If you are holding the note yourself, get all details in writing.
Charge at least the applicable federal rate in interest.
Keep any gifts to your kids separate from the second home sale.
Did you know?
The IRS is on the alert for disguised gifts in the form of inter-family home sales.
Typically you won’t be interested in becoming a bank and carrying the note on the sale of your second home yourself. All that might change if the buyer is your child. Let’s say you’ve looked over the idea of simply giving the second home to your kid, but that isn’t appealing. Or maybe you don’t want to give the second home away, but you would like to make it easy on your child to buy the house. Get everything in writing and handled above board and it’s easy to make the IRS happy and still give your kids a chance to purchase your second home on very favorable terms.
Interest on the Note
Let’s say your second home is worth $100,000. Your son gives you $10,000 down on the property and you take back a Note and Deed of Trust for the $90,000 remainder. Put everything in writing, particularly the amount of the payments. The key to this transaction is at minimum you must charge the applicable federal rate, also known as the AFR, on the loan. This rate can be found monthly at the IRS and is substantially below the average commercial mortgage rate.
The child buying the house can deduct the mortgage interest paid from their taxes, and on the other side of the coin, you will have to claim the interest income. The paper trail is important here. Your kid needs to make all the payments on the second home note. If you want to help them with the payments you can give them up to $11,000 via the annual gift-tax exclusion, but make sure the note and the financial gifts are kept separate. If you begin forgiving payments the IRS may decide to step in declare the sale a below market bargain sale completely changing the tax implications.
A nice byproduct of financing a second home sale to your kids rather than simply gifting the home to them is your kids’ tax basis on the property will be the sale price, not the lower amount you originally paid for the second home if they decide to sell the real estate.