taxes on family loan for mortgage downpayment?

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rjc32000
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Joined: Sat Jan 12, 2013 4:11 pm

taxes on family loan for mortgage downpayment?

Post by rjc32000 »

The love of my life and I are in the process of purchasing a home together. We are a little cash poor, but have an offer from a family member to do a short term loan to cover part of our 20% downpayment.

My partner and I are putting approx $110k towards downpayment ourselves, and family member has offered to loan us remaining $30k with expectation that we pay it back when our current home sells.

Are there any tax implications we need to be aware of? Current plan is to do a wire transfer from family members USAA checking account to my USAA checking account. Other option is to do a transfer from family members Vanguard MM account to my Vanguard MM account. Are there any concerns (other than the obvious: don't borrow money from friends/family) we should be aware of? I don't want the IRS to see this deposit into my account and think it is taxable income. Any advice is welcome and appreciated.

rjc32000
kaudrey
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Re: taxes on family loan for mortgage downpayment?

Post by kaudrey »

The IRS does not look at your bank statements.

You should have documentation that proves it is a loan and not a gift, so that your family doesn't have to claim the gift on their taxes.

Note that the mortgage lender will be very interested in your bank statements and will ask about the large deposit. You'll also have to factor in the repayment terms of the family loan into your level of debt and cash flow availability.
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Rainier
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Re: taxes on family loan for mortgage downpayment?

Post by Rainier »

Yikes.

Any gift you receive is never taxable to you. IRS doesn't see bank statements. All they get is 1099s and W-2s, and a few other things.

If you are paying interest to the family member they must report interest income, that's not your problem though.

If they don't charge interest (or you don't pay it) the imputed interest is basically a gift to you. The amount is trivially small and would just be part of their annual gift exclusion. Again, not your problem.
Topic Author
rjc32000
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Re: taxes on family loan for mortgage downpayment?

Post by rjc32000 »

Thank you. We have already factored in loan repayment to family member in our analysis of what we can afford.

We've got more than enough assets to cover the downpayment ourselves ad have provided proof of this to lender. But taking a short-term loan from family member will save us an awful lot in short-terms capital gains tax and won't present a hardship to the family member.
kaudrey wrote:The IRS does not look at your bank statements.

You should have documentation that proves it is a loan and not a gift, so that your family doesn't have to claim the gift on their taxes.

Note that the mortgage lender will be very interested in your bank statements and will ask about the large deposit. You'll also have to factor in the repayment terms of the family loan into your level of debt and cash flow availability.
Topic Author
rjc32000
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Re: taxes on family loan for mortgage downpayment?

Post by rjc32000 »

Thanks, Bill. I appreciate your input.

Out of curiosity, which are you "yikesing" to? I posted my question in hopes that folks would share their concerns with me; why "yikes?"
Rainier wrote:Yikes.

Any gift you receive is never taxable to you. IRS doesn't see bank statements. All they get is 1099s and W-2s, and a few other things.

If you are paying interest to the family member they must report interest income, that's not your problem though.

If they don't charge interest (or you don't pay it) the imputed interest is basically a gift to you. The amount is trivially small and would just be part of their annual gift exclusion. Again, not your problem.
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Rainier
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Re: taxes on family loan for mortgage downpayment?

Post by Rainier »

No real concerns from me. I'd document everything so there are no misunderstandings.

My only yikes was on the misunderstanding of the IRS looking at your bank statements. Again, they don't really do that unless you are committing massive fraud.
Topic Author
rjc32000
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Re: taxes on family loan for mortgage downpayment?

Post by rjc32000 »

Sorry, I'm not the most savvy person when it comes to taxes, so I'm grateful for the wisdom of the forum!

I always understood that any banking transaction in excess of $10k was reported to IRS, which was the basis of my concern.

Thanks again for your response!

Rjc32000
Rainier wrote:No real concerns from me. I'd document everything so there are no misunderstandings.

My only yikes was on the misunderstanding of the IRS looking at your bank statements. Again, they don't really do that unless you are committing massive fraud.
FoolishJumper
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Re: taxes on family loan for mortgage downpayment?

Post by FoolishJumper »

I didn't see a concise answer to your question, so I'll answer. While things like documentation are clearly recommended (you can write up a demand loan note - PM me if you would like a copy of the one I have used, or you can google for samples - it is probably not the best option to hold up in court between yourself and your family member, but it will certainly suffice for the IRS), as you don't want any uncertainty on loan vs gift (in no case would it be taxable income). Keep in mind the mortgage company will require you and your family member to sign a gift letter. That doesn't mean you can't have a loan between you and your family member; it just means that the family members is agreeing that they have no claim on the property, so they cannot file a lein against your property. What you'll have is an unsecure loan between the two of you.

That all said, the main requirement is related to taxable interest, and the IRS will bite if you don't stay clear of the laws on it. The requirement is that your loan must have a minimum interest of the 'Applicable Federal Rate', which is essentially the minimum interest that can be charged. You can find the monthly AFRs here. There is no requirement that you pay the interest, but there is absolutely a requirement that your family member pay taxes on it. If you don't pay interest, then what that means in practice is that they gift you the minimum allowable interest, and they still have to claim the interest on their taxes - there is no reason you can't gift them the minimal tax they pay.

If you will be paying a fair interest rate, there is the option of them claiming the AFR (so you might as well pay with your regular payments to them), but you gift them additional money for their generosity. Saves them on taxes, but you need to clearly differentiate the interest from the gift. Family is easy as you can just send them a birthday and christmas (or enter other appropriate holiday here) gift each year; the legal standpoint is important because if you set up a interest + gift arrangement, then they have no legal recourse if you don't pay the gift portion. The additional gift is precisely that.

What applicable minimum rate is used is extremely critical, as you can see the current month AFRs range from 0.3% for short term to 3% for loan term (I see to recall the IRS views 0-3 year as ST, 3-7 years as mid-term, and 7+ as long term, but don't depend on that info). If your verbal agreement is a mid or long term term (you state the loan is just a bridge until you sell your current home, so probably not), then by writing a demand loan, the loan does not have fixed payment schedule, so you are safe with using short term rates. In fact, a demand loan makes most sence in your situation, as you don't know when you'll pay back, and I assume you won't pay back until you sell your home (whether in 1 month or 10).

One last point, you have no obligation to send them a 1099-INT. So once the dust settles (or at a minimum at the end of each calendar year), calculate simple interest for however many days you had the money, and they need to include that amount on their tax return under taxable interest.

All that said, I'm not a lawyer, so I'm certainly not your lawyer.
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Kosmo
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Re: taxes on family loan for mortgage downpayment?

Post by Kosmo »

There should be no tax issues for you. But the family member will need to declare the interest you pay to them as income.

Does the mortgage lender know about this? They certainly do look at bank statements to ensure you have sufficient assets and income to be able to repay the loan. They will question any large deposit ('large" is subjective, but perhaps anything over $2000). You need to be able to to show where the money came from. And they may factor in a reduced mortgage amount because you'll have another debt to pay which will affect your monthly payment ability.
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archbish99
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Re: taxes on family loan for mortgage downpayment?

Post by archbish99 »

FoolishJumper wrote:Keep in mind the mortgage company will require you and your family member to sign a gift letter. That doesn't mean you can't have a loan between you and your family member; it just means that the family members is agreeing that they have no claim on the property, so they cannot file a lein against your property. What you'll have is an unsecure loan between the two of you.
This is actually the problem. When we refinanced, we considered getting a loan from my parents to bring it down so we wouldn't have PMI. Our mortgage lender didn't permit the proceeds of any unsecured loan to be counted toward showing we had an appropriate amount of money for closing. If they want you to sign a letter that the money is a gift, you've just committed mortgage fraud, because you separately have a loan agreement with your family (verbal or written) that says otherwise.

You might actually be okay without that letter, though -- you have enough assets to pay the downpayment without issue, and the loan is actually for investing. (Which is to say, for not selling the appreciated shares you would otherwise sell.) I would take the loan from the family member, disclose it to the mortgage company, and let them exclude the proceeds. It sounds like you still have enough money to satisfy the underwriters without it.

Talk to your lender and frame it as "We're considering getting an unsecured loan from a family member. What documentation will you need for that?" As FoolishJumper said, their main interest is that you actually have enough assets to qualify for the loan you're getting and that no one else has a competing claim on the property if they foreclose. Both of those are true, you just need to help them do their due diligence and prove it.

(Oh, and taxes: If you pay them interest on an unsecured loan, it's taxable ordinary income to them and they're required to disclose it. (I don't think you're required to supply a 1099-INT, but check the requirements to be sure.) If you don't pay them interest, it's still taxable ordinary income to them in the amount they "should" have charged, which they then gift to you by not charging it. They're still required to disclose the interest on their return, but the gift should be small enough not to require a gift tax return. Isn't the tax code grand?)
I'm not a financial advisor, I just play one on the Internet.
MathWizard
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Re: taxes on family loan for mortgage downpayment?

Post by MathWizard »

rjc32000 wrote: ...
I always understood that any banking transaction in excess of $10k was reported to IRS, which was the basis of my concern.
...
I believe the $10K and above reporting requirement applies only to CASH transactions. So unless relative is bringing
in a suitcase full of cash, this would not apply.

See:
http://www.irs.gov/Businesses/Small-Bus ... ecrecy-Act
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