Gift or loan?

[JohnH]

Taxpayer received a very large inheritance last year. She decided to be generous with her only son & daughter-in-law, so she gave them $500,000 each. Then she "lent" them an additional $400,000 to buy a home. She doesn't want to charge them interest (because she has decided it's unbiblical), so she said they could just repay her $2,000 per month. There is no promissory note, documentation, or recording of the loan. She also said that if their business isn't doing well at any time, they can just skip payments if they wish.

I explained to her that the "loan" is problematic for a couple of reasons. First of all, there is the matter of imputed interest required to be reported on her return. Secondly, without a recorded mortgage, the son & daughter don't derive any tax deduction for any interest paid (imputed or otherwise). Naturally, their tax preparer is completely puzzled by the fact they say they are paying $2,000 per month on a home loan, but there is no interest deduction. The tax preparer is pestering them for "documentation."

Right now she is on extension while we think this through. I'm seriously considering advising her to treat the $400,000 as a gift and adding it to the amount reported on the gift tax returns. Anybody have any thoughts on this odd situation?

[FEDUKE404]

Gift likely

Sure sounds like a gift (likely all $900k) to me.

If client thinks otherwise, find those loan documents to include necessary verbiage plus legal stuff to be deemed "home mortgage interest."

Absent that, even with a "loan," interest (apparently of the imputed type?) would be personal and still no tax deduction for the destitute homeowners.

( Be sure to remind the parent she likely has some new numbers to put on HER Schedule B. )

And if donor has any more spare change lying around, consider another gift to her tax people.

FE

[Kram BergGold]

My 2 Cents

If the children are making payments to the Mom it is not a gift, it is a loan.
If it is a loan then here are the options I see:
1. Evertime someone makes a payment I would figure out how much is interest and how much principal. This avoids having to deal with imputed interest. This will work as long as there are somewhat regular payments.
2. Deal with imputed interest.
3. Formalize this thing and recored a mortgage so the borrowers get a tax deduction. The Mom is going to have interst income to report no matter how this is set up.

Or, the Mom chooses not to take payments from the children and then you hve a gift.

[JohnH]

Sure sounds like a gift (likely all $900k) to me.

If client thinks otherwise, find those loan documents to include necessary verbiage plus legal stuff to be deemed "home mortgage interest."

Absent that, even with a "loan," interest (apparently of the imputed type?) would be personal and still no tax deduction for the destitute homeowners.

( Be sure to remind the parent she likely has some new numbers to put on HER Schedule B. )

And if donor has any more spare change lying around, consider another gift to her tax people.

FE

It has crossed my mind to suggest that I'm not too old for adoption.

[Roland Slugg]

A below-market (or interest-free) loan, typically between family members, is a "gift loan," and a special rule applies. It's treated as: (1) a loan to the borrower/donee in exchange for an interest-paying note, and (2) a gift to the borrower of the funds to pay the interest. The amount of the gift depends on whether the loan is a demand loan (Code §7872(a)) or a term loan (Code §7872(b)).

[FEDUKE404]

In search of that wascally interest

If the children are making payments to the Mom it is not a gift, it is a loan.
.
.
Or, the Mom chooses not to take payments from the children and then you have a gift.

Essentially agree on distinction between loan versus gift.

Even with "no" interest, the repayment schedule for the $400k is somewhere in the range of 17 years. Hmmm....

I definitely see the need, somewhere, for separating interest+principal from the monthly payments. Imputed, or otherwise.

And I also think, absent further information/documentation, meeting the burden for deductible interest on their starter home may present a problem. "Qualified residence interest is interest you pay on a loan secured by your main home or a second home. Your main home is where you live most of the time."

As for the "gift loan" mentioned by Roland Slugg, that is new territory for me.

SURELY no one hands over a $400k "loan" without some kind of written legal documentation / agreement ?

Good luck with that adoption, JohnH !!

FE

[JohnH]

Many thanks to each of you for the interest you have taken in this and the advice. Looks like I have some reading to do regarding "gift loans" - I never knew there was such a thing.

The biggest problem with the whole arrangement is that there is no promissory note or documentation of any kind. She simply transferred the money to the son & wife in mid-2013 and she suggested that they pay her $2,000 per month, which they have been doing since Jan 1, 2014.