Ep. 50 The Modern Real Estate Dilemma: Gifting or Loaning to the Next Generation
The Financial Commute

Ep. 50 The Modern Real Estate Dilemma: Gifting or Loaning to the Next Generation

Ep. 50 The Modern Real Estate Dilemma: Gifting or Loaning to the Next Generation

The Financial Commute

On this episode of THE FINANCIAL COMMUTE, host Chris Galeski welcomes Wealth Planner Brian Standing. They discuss potential complications that may arise when a parent or grandparent helps their child buy real estate.

Firstly, it is critical to decide if the financial assistance offered is considered a gift or a loan. Gifts may be subject to gift taxes, and there may be income tax consequences for loans. Furthermore, it is important to ensure your child is financially stable enough to maintain their property and pay property taxes after they become a homeowner. If you are helping with a partial down payment, your child still needs to be able to qualify for their own loan so they can be on the title.

Another area of potential complexity is when a child’s partner is involved, as a parent or grandparent may want to ensure that their contribution is protected. Prenuptial or postnuptial agreements can be made to specify how the property will be treated in the event of a divorce.

Other issues to consider are changing life circumstances (your child may not stay in the same area for the rest of their life) and equalization among heirs to establish fairness.  

Brian and Chris agree it is always important to have conversations with your family and wealth advisor about these intricacies before gifting or loaning a substantial amount of money to another family member.

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Hello, everybody, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by Wealth Planner Brian Standing. Brian, thank you for joining us.

You are welcome.

Exciting times. I mean, often you and I get together. We talk a lot about estate planning, ideas and strategies and limits and just that whole realm of decisions that we need to make with regards to certain trust structures or gifting.

I love all these things.

But today we're talking about whether or not it makes sense for parents or grandparents to help their kids or grandkids purchase real estate. As real estate prices have increased a lot the last several years, we are seeing it be a lot more common where parents or grandparents are gifting money to their kids or grandkids to help purchase real estate.

And this can create a whole host of issues that people may or may not be aware of when they are quick to make a decision. I shouldn't say quick to make a decision. They probably thought and planned this out for a really long time, but by the time they call myself as their wealth advisor and say, Hey Chris, would you mind?

I could use X amount of dollars so I can help so-and-so purchase a property right? I may be too late to have some of these conversations, right?

Yeah, I, I didn't expect this to become a specialty, right? I do estate planning. I set up wills, interests and I don't think there's a quarterback on this topic because you've got the parents and you've got the kids, you've got estate planning, you've got some tax overlap, you've got income taxes and property taxes. And for some reason the questions come to me.

Sometimes they regret it because I show them how complicated this can get. And then if the kids like my mom's not helping me anymore and I'm like, I'm sorry to tell you, but I think it's worth just going over those issues. I'm having so many of these conversations that if someone can just, you know, grab this and get a quick summary, I think it'd be useful.

I mean, you've been a practicing estate planning attorney for 14 years.

15 years.

15 years. And then in the last 15 years, have you ever had this conversation about helping other generations purchase property as much as you're having it now?

So we've always had these issues come up, but it's frequent now just because, you know, it's expensive, you know, all the places where the parents live are not the places where the kids can necessarily afford to live. Yeah. And you know, we have clients or you know, some of my younger clients are looking to move out into places that are more affordable.

Yeah, which is great. But sometimes the parents are saying, well, wait a minute, if I help you out, will you stay around?

That might not make sense. Maybe their job may take them somewhere else. Sure. You know, owning a piece of property says that you want to put roots down and you're planning on probably being there for at least 5 to 7 years. Right. Because you don't want to go buy a place and then 6 to 12 months later, I have to turn around and sell it.

Mm hmm. You're subject to fees and commissions.

Yeah, no, I. I think that's a great kind of starting point because people want to get into. Okay, is it a gift or is it a loan? And what about the income taxes on the property and the deduction? All of that becomes sort of secondary to the gut check, which is like, does this make sense? What are we doing here?

And we look at that from both sides, both the parent and the child receiving the help. They're right on the parents side. It's maybe a financial question. And so we want to make sure they have financial planning in place. Let's say they have three kids and they want to give, you know, 500 K for a down payment to one.

Have they, you know, planned in 1,000,005? Because what happens when the second child and the third one. Right. And can they still sort of meet all their goals, retire whatever they want. Yeah. Having now committed to potentially making these substantial gifts.

You're talking about the fair and the equal component of being a parent or grandparent.

And most of my clients are going to be in the boat where if we're going to help one with a house, we're going to help you know all that. Sure. And then on the on the child side there, there's a financial component, right? If they're the one getting the loan right, need help getting the the down payment and they're going on the loan, can they support that payment reasonably?

Right. So they're not just barely making ends meet with the mortgage and then, you know, have enough for other things. So they need to do some financial planning as well. But I think on the child side, there's also the personal element which you touched on, which is if you're in your late twenties, are you ready to commit to living somewhere?

Who knows where you want to be? Right? And so the parents might be almost encouraging you, Yeah, let's buy something. Let's stop renting. It's so expensive, you know, Let's stay local. You may not know where your life is going to take you and, you know, getting into a property and then sort of being stuck with that. And now you need to maybe sell it or becomes a rental.

That just doesn't make sense for a lot of younger people. So there's really a, you know, like, does this make sense? And then I kind of got a funny story I could share on this, which is there was a client who was getting to that stage, so actually married. So the parent helped the child and his spouse get this property right.

And it was just all financial. There was no like strings attached, apparently. So they're starting to move stuff in and, you know, bringing stuff upstairs. And, you know, mom walks into one of the first bedrooms upstairs and goes, this would be a good nursery. Well, the daughter in law looks at the at the son like what she just say, like we didn't have this conversation.

And so the parent was like, hey, if I help them get a house, they'll move on to grandkids. And they weren't ready to have that conversation. And all of a sudden they're feeling pressure from day one. Oh, I helped you with the home. When am I getting those grandkids? You got to be aware of that kind of stuff.

It is funny how that happens just in life in general. You get engaged and most people's initial reactions. When's the wedding? It's like I just got engaged here a minute ago. And then on your wedding day, it's like, Oh, congratulations. Got married. When are you going to have kids? It's like we just literally said, I do. It is funny how that can just happen in society, not just with Mother in laws or in-laws, but yeah, it can happen in general.

So let's say, let's say we've done all the planning and the parent or grandparent can easily sustain a gift to one grandchild or several grandchildren or kids to be able to help them with buying a property. Let's talk about all of the issues that come about when people do this. Is this a gift or is it the loan is the first question.

Yes.

And the issue here is that people seem to intentionally really fail to take a position on this know. In other words, they know that if it's a gift, they have to file a gift return. They have to tell the IRS by the way, I'm giving a bunch of money away.

Right.

And it's not a big deal, but it is sort of irrevocable and it's some work to do. And so they sometimes will say, no, it's it's a loan. They'll pay me back.

Well, yeah, but then all of a sudden they might not qualify for the loan to the bank to get the rest of it. If that's stated as their own.

So typically when, when you're getting if it's the child who's getting the loan, there is a document where you have to sign that this is a gift. Right. You know, they're not getting two loans. Right. And I don't think people should be in a position to represent something for financing purposes as a gift if it's not really like why even get into that kind of issue?

And then of course, people say, well, no, it's a loan. You know, I'll give it back over time. Well, if it's a loan and not a gift, you now have payments that are required from your child. Those have income tax consequences. Whether or not they make the payment, there's income tax consequences. Right. And so if you're not filing annually and recognizing this income, even if you don't get it, you're now in this weird position where it is a gift, but you didn't file a return and we just need to be clear about what we're doing now.

So, yeah, it's an interesting question and one we need to address right upfront. Is it a gift? If so, then maybe the child is getting the loan themselves if they can't qualify for the loan. Well, now we get into all the parents going on the loan and it gets really messy. Yeah.

Oh, and then what about the other extreme with the parents just buying the property and saying you can live in it, it's yours that comes with the misuse or risk.

I think if it were me and that was being done for my benefit, I would really want to consider whether this is an achievement at all, whether this is something that makes me feel like I've earned something or that I'm proud of something. You know, I'm not so sure being handed a house. Yeah.

Is it really what you want? If you really were to sit back and look at your life and this is more philosophical, maybe, but like, you want to, you want to have those accomplishments where you sort of scrape together money, where you, you know, got a property for yourself. And maybe it wasn't perfect, but you made it work.

I mean, these are like some of the best times in your life. Sure. And so you have to be careful to just say, you know, just move into a property and it's given to me.

Well, I was also thinking about it from the other aspect. Okay. Let's say that, you know, the parents buy the property and you move into it and you're living in it and they say, Oh, this is yours. And then you wake up, call it five, ten years down the road and you, you know, want to upgrade, you want to sell this property and upgrade to a new one.

Yeah, well, you're not technically the owner if you're the kid. And so when you go to sell that, you don't get that $250,000 capital gain exclusion. Yeah, it's actually an investment property for the parent.

Well, nor do you receive the proceeds on top of that for your parents or the wife selling the property and so you can ask them to buy you a new one. Yeah. When you grow out of it or when you want to change cities or something.

I was just thinking about it from that awkward stance.

But that's correct. Right. It's technically a rental to the parents. You're supposed to be paying rent along the way. Otherwise it's a gift if you're not paying rent. It's really complicated. And yeah, the parents receive the money from the sales proceeds and so you don't actually own anything. Yeah, I think more typically we see help with a down payment.

Right. Because it's just the the prices are just such that having that 20% without help is challenging.

Yeah. And being able to qualify for the loan, to be able to make an affordable payment, you probably need to have a larger down payment today because interest rates are higher. Yeah. And they're still very reasonable. Oh, you know, compared to history.

Sure.

But it's definitely a lot more expensive than it was a year and a half ago.

Yeah. Yeah. So, so the most common scenario is help with a down payment, which is a gift, but child qualifies for the loan. And the key to that is we want the the child to be able to qualify for their own loan so that they can own the title.

Once we know this makes sense that we all want to do this, it makes sense financially. The person that gets the loan is the one who goes on title.

And then if they have the loan in their own title, then they get the mortgage interest deduction. They qualify for that $250,000 exclusion if they were to sell it later on down the road. And then future property tax to talk to me about that.

Yeah. So what we're doing is we're telling the story consistently from an estate tax, from an income tax, from a property tax. We're telling the story that this is the child's property. And we do that by saying down payment was a gift. We file a gift tax return. That's a transfer to the child loan is in the child's name.

Therefore, properties in the child's name, because whoever takes the loan has to own the title because it secures the loan. Yeah. And so now we're in the world where a child owns this property cleanly. We have mortgage interest deductions that we can take and state local taxes in California here, we, you know, don't really get the benefit of those.

Your California taxes. Are you going to cap your, you know, 10,000. So again, we're now in the place where they own the house. They get the income tax deductions. They have the 250 exclusion. If there are two spouses, let's say, on title, you know, maybe 500, maybe we'll get to that in a minute about how we address the the personal issues when one family gets the money.

So we have the future 250 or $500,000 exclusion from gain. There's a slight benefit from a property tax standpoint on a personal residence. You get to chip a little bit of principal off on your tax payment plan, a huge deal, 500 bucks a year. But we don't have to worry about later changing the title, right? If we have a parent owned property that then changes to a child, we might have a property tax reassessment.

Right? We might update the taxes later, which we wouldn't want to do.

So the key thing if a parent's going to do this is to make sure to determine, is this a loan or is this a gift? If it's a gift, we have to make sure that my child qualifies for the loan and they go on title right that way. They're filing the right forms for taxes and property tax purposes and ownership.

And then the parent that made the gift they have to just file a gift tax return to account for that debt.

Sure. Assuming that the gift exceeds annual exclusions, which I mean can add up. Right. If you've got maybe, you know, child and spouse, it's 34,000 per parent, you know. Right. So you can go up 68,000. Maybe that's all they need. We do have to then address like, okay, why are they both going on title. Is it going to be owned by both you know child plus spouse.

Yes. So let's walk through that example. Okay. Let's say that the parents are giving their their child money for a down payment and that child is, you know, married or in a relationship with somebody else to who's not contributing anything.

To the down payment.

Right. And they might be, you know, helping support the mortgage payments, but not.

Right. So anyway, so then we go again to the loan piece, right? Let's say it needs both incomes to get the loan. Well, we then we know both are going on title great, right. We've got this 250 K or whatever was gifted by one side. And so the question is, do we want to take some action to protect that contribution, to basically keep track of where that came from?

There are some parents who maybe they just love their in-law, you know, it doesn't matter. And you know what? It's a gift to both of you. You know, it's our pleasure. Other people say, no, we want to protect that investment. And so in that situation, we'll probably want something like a property agreement, but can be kind of worked into like a prenuptial agreement if it's all happening, like as they're getting married.

But let's say an agreement around property that identifies who contributed what, what happens in the event of splitting up, what happens in the event of a sale. Maybe the 250 comes back to one side. The excess appreciation gets split between the two of them. This is something that is not an estate planning issue. This is a family issue.

Family like because it sounds a lot like a prenuptial agreement.

It is basically with respect to one asset, you know, and this is one where you need family lawyers. Each would have your own family lawyer do an agreement, make sure you both understand it and you sign it. Not a fun process, but if the result is you get a house you couldn't have otherwise had in the neighborhood you want, most people are like, Let's do it.

I mean, just the whole host of issues that you've brought up so far means that there's a lot of conversations that should be had when you're preparing to possibly help your child or grandchild with a down payment on a property, especially to make sure that, you know, ownership title and then who's on the loan, making sure that there's things in place to help protect that investment if it is bringing significant others into the fold that are not contributing.

Yeah. And then the final piece is, you know, the best part of this, which is more estate planning to do. Right? Right.

So talk to me about more estate.

So if you're on the parent side of this and you need to determine whether this contribution is properly reflected among maybe all of your children. Right. Maybe others aren't buying a property and so you need to go into your plan and say, well, if I haven't helped the others, I want you to make an equivalent gift off the top.

You know, does that give scale because they got it now and in the future that same amount of money isn't the amount it was when they got it?

Yeah, you're talking about depreciation, right? So when I talked to my grandmother and she says, I remember when a Coke only cost a nickel, right now it's $3, Right. That $500,000 down payment today might not be able to buy the same type of house.

And let's say your other child doesn't want to buy a house or has a house. And you say, well, I'll just give them 500,000 off the top in my estate plan, But you don't die for 20 years. That's not the same, right? Them having 500,000 now, they would have obviously hopefully made money with that. And so do we need to account for that?

Do you just want to make other gifts now so you don't have to worry about it in the future? So that's one issue. If the parent is on title, which child can't qualify, they want them to have a house and so the parent buys it. Well, now we need to go into the plan and make sure that property gets allocated to the child who's living in it.

You know, we then need to account for, well, who's paying along the way? Do we need to account for some of the child's contributions? Because otherwise, if that's a $2 million house and it just gets allocated, you know, that's 2 million less as far as what goes to that child versus the other. But they may say I paid into it.

That's fair. Right? So some parent issues, if we were dealing with estate planning on helping on the child side, hopefully they're the one on title. Well, if you own something on title, well, maybe it's time to do your first estate plan, right. A real estate is a type of asset where if you don't have estate planning, living trust, it goes through probate.

Right. And so you may want to avoid that. You may want to have a trust that now allows that asset to avoid going to court. If you pass away, leaves it to the people you want, etc..

Definitely a lot more estate planning needs to go into this when you've had these conversations. I just think about the equalization aspect. If you've got multiple kids and what that looks like, you know, our best advice is if you're going to be having these conversations with your kids and grandkids and you're looking to help them out, let's engage in a conversation that makes sure if this is a gift or if it's a loan, whether or not they can best qualify for ownership of that property and what other sort of things that you need to consider when helping out future generations.

Brian, thank you so much for joining us.

You're welcome.

Disclosure: Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your financial, legal, and tax professionals before implementing any transactions and/or strategies concerning your finances.