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July 28, 2008
How to pay back family investor for downpayment contribution in 20 years?
A family member is helping us with the downpayment for our new 2 family home. He basically paid half our downpayment. He doesn't want any return in the short term and won't be responsible for any bills or get any mortgage benefit. He wants it like a long term stock investment. But we're stuck on how to get him back the money. Assuming the property appreciates, is there any way to return his original payment plus appreciation without him having to pay tax on ordinary income (versus a capital gains tax on real estate, which we would pay on our real estate (presumed) gain.) How could we return what may be a six figure payback (since the gift tax takes effect after $48K). Should his name be on the deed? Grateful for answers or any pointers in the right direction to a tax or legal advisor who has handled such a situation before (willing to pay for the service too.)
Comments
Try googling economist Andrew Caplin, New York University. He and others have done work designing standardized shared equity mortgages, somewhat akin to Islamic funding models. Also, in April 2007, BusinessWeek reported on family members helping out by taking an equity stake in their younger/poorer relatives' homes.
Posted by: vinca at July 29, 2008 12:55 AM
Just put his name on the deed. When you sell, family member or his heirs will get the profit. Work out the percentage w/him, no need to spend $ on advice from professionals. Write it out and go to a notary public.
Posted by: pattunia at July 29, 2008 2:01 AM
Thx Vinca - Andrew was my first stop and he told me he had no practical advice, only theoretical research! I read the bw article too and it had no other sources to pursue!
Posted by: wjcohen at July 29, 2008 7:58 AM
Why not spread the repayment out over 2 or 3 (or 4 ...?) years when the time comes. That way you can keep it within the gift limit.
Posted by: serpentor at July 29, 2008 9:53 AM
Alternatively, you could just suck it up and treat it like the investment income that it is.
Posted by: serpentor at July 29, 2008 9:54 AM
Important -- don't forget that you're subject to paying income tax this coming year for the amount transferred between your relative and yourself for the down payment (minus the gift tax deduction). Current gift tax rules allow up to $11,000 to be given from one person to another without tax, and anything over that follows the gift tax rules and would apply to you as income. This would apply to you even if your relative wrote the check straight to the seller.
You'll also incur a gift tax when you return a payment back to your relative.
The IRS has information on the details of the gift tax regulations at:
http://www.irs.gov/businesses/small/article/0,,id=98968,00.html
Posted by: Smokychimp at July 29, 2008 10:13 AM
WJ: I am a blue collar worker--certainly neither attorney nor accountant--and not going to attempt to offer the guidance you should absolutely obtain from a professional. I do, however, know something about death, families, and original agreements and intentions that blur over time. Put your agreement in writing, and do it with the help of a knowledgeable and mutually-respected professional. You might want to discuss a forgiveable loan, with minimal annual interest payments at an agreed rate, and a balloon payment at "x" rate triggered by event(s) of your naming. If you provide an Email address, I will send names of two people who impressed me at seminars (but with whom I have no other personal experience).
Posted by: vinca at July 29, 2008 10:54 AM
Vinca's is good advice. You don't want this thing becoming a bugbear down the road.
Posted by: Smokychimp at July 29, 2008 10:58 AM
WJ, I am sure there are ways to structure this to minimize the tax implications identified above. A gift followed by a return of a much bigger gift sounds like it might be about the worst way to think of this. Is this a loan? An investment? Find an accountant who is also a lawyer (many are both) to help you structure and memorialize this so that you accomplish your goals, make all obligations and financial arrangements with your family crystal clear, minimize the tax implications, and comply fully with applicable laws.
Posted by: slopefarm at July 29, 2008 11:02 AM
I agree, forget "gift" concept as he/she will be looking for a return of 1/2 deposit plus a "to be determined return". Sounds like an investment.
It can be structured like a loan with an accrued interest (a preferred return which can be low) and a share of profits at a capital event (refi, sale,tranfer etc) and or set a period (say 20yrs) when it is due and an appraisal can be used to determine balance due.
As simple as this is (joint venture agreement) there are many moving parts and it should be handled by a professional.
Posted by: chas at July 29, 2008 11:53 AM
Regarding taxes, accrued interest would be income and appreciation would be capital gains. That is why investor may want nominal interest rate especially if they are bullish on appreciation.
Posted by: chas at July 29, 2008 11:59 AM
Thanks all for these valuable insights. Vinca, I'd be grateful for leads for professionals - i'm at wjcohen at yahoo.com.
Posted by: wjcohen at July 29, 2008 1:45 PM
why not structure it as a loan, at a reasonable interest rate for both. you could write a note that would allow you to pay down principle at set intervals during the term of the loan, thus lowering your interest payments, while not surprising your investor with too much principal back at one time. there would be no gift tax implications to you as it is a loan. keeping it as a loan might circumvent disputes and hard feeling over ownership and appreciation issues later, such as what you might need to do to allow your investor to cash out at a time when you don't want to sell; or who shares the expenses of selling down the road; or how to apply the appreciation to the house vs any improvements you make over time.
Posted by: raphael9 at July 29, 2008 5:20 PM
You shouldn't rely on this board - you need a real professional to help do this. Basically, you will want to put him on title and have a separate agreement that his only rights are to get x% of the profits on a sale of the property. You will need to find a bank that understands all this to lend you money. You will need to ask a professional, but I don't think there is any reason why his profits wouldn't be treated as capital gains in that instance.
Posted by: superlawyer at July 29, 2008 5:51 PM
you cant do it as a loan if youre getting a mortgage. it could be "equity" in some form or another. i doubt you'll be able to avoid taxes on profits entirely.
Posted by: slick at July 30, 2008 3:48 AM
I don't think that a "real professional" is needed for this, as long as things are carefully outlined at the outset. How soon do you hope to close on this property? My advice would be to do the following. However, you need to TRUST each other very much. 1) Open a joint bank account with the person who is lending you the money. If it's a sibling or a parent, that shouldn't be too difficult. Keep the money in the account for awhile. (Alternately, have your name put on the account where the money is coming from.) 2) Draw up an agreement...vinca and slopefarm have good advice concerning what to include. I suggest a "start" date for repayment, that is about 6 months to a year after the mortgage starts. That gives you some time to get back on your feet after the initial house expenses. Make sure that your relative gets a favorable rate of return. It may be a kind of favor, but it's still YOU using HIS/HER money. You should also make a reasonable term for repayment. If your relative is not getting a percentage of the sales profit, I wouldn't make him/her wait to long for the money. Then, when you start paying back, you pay it into the joint account. Good luck!
Posted by: Minmin at July 30, 2008 10:11 AM
I have a similar situation in that my father-in-law gave me and my husband a money for our downpayment. He also does not expect a shortterm return as he sees this as a long term investment. Our understanding of gift tax is that the donor pays the tax on the gift, but the receiver does not have to claim this as income. I did (what I thought at the time) was quite a bit of research on the issue as I knew that we would not be able to afford the tax on the amount so wanted to avoid this if possible. From these comments I fear that I may have made a terrible error, but I just looked at the IRS's website again and it still seems to me that the donor pays the tax on the gift - not the receiver. Any thoughts? Fortunately, for my father-in-law he is not a US citizen and does not live here so was not subject to US tax laws on his gift.
Posted by: Turtlejam19 at July 30, 2008 1:09 PM
Also, the gift cap is $12,000 per person. So if your relative has a partner and you have a partner, the allowable gift is actually more like $48,000.
Posted by: serpentor at July 30, 2008 10:36 PM
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