Intra-Family Mortgage INSTEAD of Investing

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virginiabirdie
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Intra-Family Mortgage INSTEAD of Investing

Post by virginiabirdie » Thu May 12, 2016 8:25 pm

I did a quick search on intra-family mortgages, but it seems like most situations are for the borrower to get a lower-than-market interest rate. I want to charge higher-than-market interest rate.

My mother has a loan on a commercial property. The interest rate is around 6%. Rather than pay interest to her bank, she proposed that I assume her mortgage and charge her more interest than 6%--she threw out 10%. The idea is to a) have the interest benefit my family, not the bank and b) for her to get a larger interest rate deduction on her local, state and income taxes.

I'm not very money savvy. So, what do you guys think?

A little more about us. My mother's property is worth at least quadruple the loan amount, even during the last recession it was cash-flow positive. Mom also has a enough personal assets that she could pay off the loan, but she doesn't want to since most is tied up in a trust. In addition, we are as close as can be--it's just us. It's dramatic, but I'm sure she'd die rather than hurt me in any way. I feel the same about her.

My husband and I are not rich, but comfortable. We have toddler-aged kids and can pay off her loan, but it would be about half of our savings. Our savings have returned probably -5% over the last decade. (Bad choices I made before learning about the Bogle way.) 10% return sounds very sweet to me! And as far as I'm concerned, there's zero credit risk. Other risk, yes--legal and tax issues, for example. So...

1) Is this just a plain bad idea? It sounds so good, I'm wondering what I'm missing.
2) I know there's a floor on how much interest you can charge without riling up the IRS. Is there also a ceiling?
3) What risk am I taking on and how do I protect myself? I'm not worried about her defaulting, but I worry about what happens if someone gets hurt on her property and sues us, for example. I worry about running afoul of tax laws. That kind of thing.
4) How do taxes work? I imagine I pay capital gains on interest received. My mom deducts the interest, even though it's more than she'd pay to a bank. Sound right? Other tax considerations?
5) Who handles the paperwork. My mom's CPA wants to do it, but I wonder if it's best to enlist a lawyer.
6) My mom wants to protect her assets from my husband. (See earlier part about not having a father present. My mom's life experience is to not trust men.) My husband is a mensch and understands completely. Is there anyway to structure a mortgage so that I'm the lender, not him, though our assets are mingled?

I know I should probably mention something about our asset allocation, etc. But we are big savers, and even with the loan, we are still comfortably on track to save for retirement and college.

I could only post this on Bogleheads. Thank you anyone who got to the end of this long post!!!

Katietsu
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by Katietsu » Thu May 12, 2016 8:47 pm

I do not feel comfortable commenting on the idea as a whole. You will be taxed on the interest as ordinary taxable interest, ie line 7 of the 1040. You will be only a mortgage holder, just like Chase Bank, so you shouldn't need to worry about being sued. The deal can be made just between you and your mother.

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whodidntante
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by whodidntante » Thu May 12, 2016 9:23 pm

It sounds like a great investment. But I wouldn't do it. This is a one sided arrangement and those typically come with strings.

Just my opinion. Good luck whatever you decide. :sharebeer

Lafder
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by Lafder » Thu May 12, 2016 10:55 pm

Why not have your mom take out a mortgage from you at 6%, and pay off the existing mortgage, and then continue to pay you the 6%.

Her interest rate stays the same.

A guaranteed return of 6% is really great!

And yes draw up all papers officially so you can foreclose if not being paid, and maybe something about you inherit the property if she passes.

I do not see a reason for her to pay 10%, in which case you only benefit 4%. Go for the full 6% and both of you benefit vs the 10% idea.

Also, I thought very few mortgages were assumable these days.

There probably is some technicality about "market rate" interest to related parties that someone can explain to us :)

lafder

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celia
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by celia » Thu May 12, 2016 11:16 pm

I think the problem will be between you and DH down the line. Is he likely to hold this over you down the road like when you need a large amount of money (a house, eg)?

What happens if you die before it is paid off? Will mom pay DH what is owed? The money will no longer be liquid. What would you do (are doing) with the money if it is not lent?

Regarding interest, it will be regular taxable income to you. It will only be deductible to mom if she itemizes.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

littlebird
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by littlebird » Fri May 13, 2016 12:14 am

celia wrote: Regarding interest. . . . It will only be deductible to mom if she itemizes.
And if the mortgage and note are properly filed in the appropriate county office.

After which you will be surprised to get innumerable phone calls from people who read these filings and want to buy the mortgage from you at a discount.

cherijoh
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by cherijoh » Fri May 13, 2016 5:51 am

virginiabirdie wrote:I did a quick search on intra-family mortgages, but it seems like most situations are for the borrower to get a lower-than-market interest rate. I want to charge higher-than-market interest rate.

My mother has a loan on a commercial property. The interest rate is around 6%. Rather than pay interest to her bank, she proposed that I assume her mortgage and charge her more interest than 6%--she threw out 10%. The idea is to a) have the interest benefit my family, not the bank and b) for her to get a larger interest rate deduction on her local, state and income taxes.

I'm not very money savvy. So, what do you guys think?

A little more about us. My mother's property is worth at least quadruple the loan amount, even during the last recession it was cash-flow positive. Mom also has a enough personal assets that she could pay off the loan, but she doesn't want to since most is tied up in a trust. In addition, we are as close as can be--it's just us. It's dramatic, but I'm sure she'd die rather than hurt me in any way. I feel the same about her.

My husband and I are not rich, but comfortable. We have toddler-aged kids and can pay off her loan, but it would be about half of our savings. Our savings have returned probably -5% over the last decade. (Bad choices I made before learning about the Bogle way.) 10% return sounds very sweet to me! And as far as I'm concerned, there's zero credit risk. Other risk, yes--legal and tax issues, for example. So...

1) Is this just a plain bad idea? It sounds so good, I'm wondering what I'm missing.
2) I know there's a floor on how much interest you can charge without riling up the IRS. Is there also a ceiling?
3) What risk am I taking on and how do I protect myself? I'm not worried about her defaulting, but I worry about what happens if someone gets hurt on her property and sues us, for example. I worry about running afoul of tax laws. That kind of thing.
4) How do taxes work? I imagine I pay capital gains on interest received. My mom deducts the interest, even though it's more than she'd pay to a bank. Sound right? Other tax considerations?
5) Who handles the paperwork. My mom's CPA wants to do it, but I wonder if it's best to enlist a lawyer.
6) My mom wants to protect her assets from my husband. (See earlier part about not having a father present. My mom's life experience is to not trust men.) My husband is a mensch and understands completely. Is there anyway to structure a mortgage so that I'm the lender, not him, though our assets are mingled?

I know I should probably mention something about our asset allocation, etc. But we are big savers, and even with the loan, we are still comfortably on track to save for retirement and college.

I could only post this on Bogleheads. Thank you anyone who got to the end of this long post!!!
There is a huge liquidity risk in tying up 50% of your savings in a commercial mortgage. If you need the money you won't be able to access it.

I would also be concerned with how the IRS would view this. Your Mom would be inflating her business expenses while transferring money to you without consideration for gift tax limits. This sounds very fishy to me. But I'm not a CPA.

IowaFarmBoy
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by IowaFarmBoy » Fri May 13, 2016 6:11 am

I'm unclear as to exactly how this will work. Are you assuming her current mortgage at 6% (so that you now have a mortgage to her current lender) and then making money on the difference between this 6% and the 10% you are charging her? Or are you planning to lend her the money to pay off her mortgage and charge her 10% for the loan and you will not have a loan to the lender?

The scenario where you are carrying a mortgage to her lender seems risky. Something can go wrong and it could end badly. The scenario where the mortgage is paid off and you have just a loan to your mother sounds a lot less risky and is tempting. Effectively, she is gifting you some money every year via the high interest rate. She gets a deduction but you are paying ordinary income tax rates on that money. So it would depend a lot on what everyone's marginal tax rates are. It might be simpler for her to just gift you or the kids some money every year.

You've gotten a lot of good advice already about making sure things are done properly in terms of the legal documents and about the family issues this could create.

mouses
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by mouses » Fri May 13, 2016 6:35 am

I am not a tax person, but I know the IRS has special provisions for various within family things, to avoid people mickey mousing. I would consult a knowledgeable tax preparer about this.

lhl12
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by lhl12 » Fri May 13, 2016 7:13 am

I don't know the commercial mortgage market well, but it surprises me a little bit that you couldn't do better than 6% on a loan from a bank. Has your mom shopped around for the best possible deal from other banks?

c1over8
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by c1over8 » Fri May 13, 2016 8:19 am

virginiabirdie wrote:
1) Is this just a plain bad idea? It sounds so good, I'm wondering what I'm missing.
2) I know there's a floor on how much interest you can charge without riling up the IRS. Is there also a ceiling?
You should definitely check with your CPA on this in case there is a rule. I don't know but you wouldn't want the IRS coming back and recharacterizing it as a gift and then finding that mom owes interest and penalties for understatement of income because she wasn't entitled to the interest expense deduction.
virginiabirdie wrote: 3) What risk am I taking on and how do I protect myself? I'm not worried about her defaulting, but I worry about what happens if someone gets hurt on her property and sues us, for example. I worry about running afoul of tax laws. That kind of thing.
You should go to an attorney, not the CPA, to draft documents. The attorney will prepare a note and deed of trust so it will be clear you are a lender and not an owner. As a lender you won't be liable for slip n falls, etc. Getting the deed of trust and having it recorded is important so that if someone gets injured and sues your mother, your lien on the property before anyone else gets a lien recorded (including someone who gets injured, gets a judgment, and attempts to levy on the property).
virginiabirdie wrote: 4) How do taxes work? I imagine I pay capital gains on interest received. My mom deducts the interest, even though it's more than she'd pay to a bank. Sound right? Other tax considerations?
Interest income is ordinary income to you. Mom can deduct the interest as a business expense, rental expense, whatever based on how she reports the income from the property.
virginiabirdie wrote: 5) Who handles the paperwork. My mom's CPA wants to do it, but I wonder if it's best to enlist a lawyer.
Get an attorney. I don't believe a CPA can prepare and record the deed of trust for you.
virginiabirdie wrote: 6) My mom wants to protect her assets from my husband. (See earlier part about not having a father present. My mom's life experience is to not trust men.) My husband is a mensch and understands completely. Is there anyway to structure a mortgage so that I'm the lender, not him, though our assets are mingled?

Double check your state but if you are using marital assets to make the loan, the interest income would be a marital asset.
Back to your first question - the only reason that having your mom pay you the extra 4% would be worthwhile is if your mom is in a higher income tax bracket than you are which gives her a larger benefit from being able to claim a deduction for the interest expense than the tax detriment to you of including the interest in your income.

If you both pay the same top tax rate or if you pay a higher top tax rate than your mother - I would propose that she pay you 6% interest and gift the rest to you each year (assuming the extra 4% interest would be less than $14,000 a year and thus no gift tax would be owed). Back to question 6 - if your mom makes a gift to you and you do not commingle it with marital assets or separate assets of your husband, then - double check your state - but this should be treated as your separate party in the event you and your husband divorce.

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Re: Intra-Family Mortgage INSTEAD of Investing

Post by pkcrafter » Fri May 13, 2016 8:22 am

This is a nice gesture for your mom to think of, but she should not get herself into a 10% mortgage. The idea she will get a bigger deduction isn't what she should be thinking about. Furthermore, it's not a good idea to get into money matters with relatives, and in fact, mom should be looking for a loan at less than 6%. What kind of property is that loan covering?

If your mom really wants to give you money, she should just do that. She can gift up to $14,000/yr.

Paul
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by hafjell » Fri May 13, 2016 8:24 am

virginiabirdie wrote:In addition, we are as close as can be--it's just us. It's dramatic, but I'm sure she'd die rather than hurt me in any way. I feel the same about her.
Loaning family members money (with or without paperwork) is a good way to strain the relationship. Are you positive a few percentage points is worth that risk? Sounds like you're both getting too cute with this.

Fixmen
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by Fixmen » Fri May 13, 2016 10:08 am

While your mom could get a tax deduction, you will have to recognize it as income and pay taxes on it. You don't really come out ahead. If you're mom wants to transfer money to you, just have her give it to you as a gift. She could give you and your husband each 14k a year tax free plus another ~$5.4M over her lifetime using the unified credit.

namenloseblonde
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by namenloseblonde » Fri May 13, 2016 11:19 am

My first mortgage was from my parents and it worked out very well. It was at or close to market rate, but for various reasons I wouldn't have qualified for a standard mortgage at that moment so it was much simpler for me to borrow the money from them. At that time, they were in their late 50s and still accumulating money for retirement, but were happy enough to have a 5% guaranteed return on what would have been part of their fixed income allocation.

This was done with complete transparency - my siblings knew that I had taken the loan, the terms, etc. No problems or hard feelings, but of course every family is different. Also, I wasn't married at the time, so there was no concern over a husband taking advantage, etc. In your situation, I would probably not do the 10%, but make the loan at 6% or whatever market rate is currently. 6% is a terrific guaranteed return on a fixed income investment!

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Re: Intra-Family Mortgage INSTEAD of Investing

Post by Meg77 » Fri May 13, 2016 11:28 am

virginiabirdie wrote: 1) Is this just a plain bad idea? It sounds so good, I'm wondering what I'm missing.
2) I know there's a floor on how much interest you can charge without riling up the IRS. Is there also a ceiling?
3) What risk am I taking on and how do I protect myself? I'm not worried about her defaulting, but I worry about what happens if someone gets hurt on her property and sues us, for example. I worry about running afoul of tax laws. That kind of thing.
4) How do taxes work? I imagine I pay capital gains on interest received. My mom deducts the interest, even though it's more than she'd pay to a bank. Sound right? Other tax considerations?
5) Who handles the paperwork. My mom's CPA wants to do it, but I wonder if it's best to enlist a lawyer.
6) My mom wants to protect her assets from my husband. (See earlier part about not having a father present. My mom's life experience is to not trust men.) My husband is a mensch and understands completely. Is there anyway to structure a mortgage so that I'm the lender, not him, though our assets are mingled?
1. I think this sounds like a great idea. Intra-family loans can be a big win-win for both parties, whether you are charging above or below market interest rates. I have borrowed money on 3 loans from my mother, and I've also done some private lending in the past (though not to family members). My mom has lent funds to my sisters as well at times. She considers it a zero risk because even if we didn't pay her back it would just come out of our inheritance. And it's just less that she has to gift us over time since she plans to do that anyway. We get the benefit of not having to deal with banks along with a lower interest rate than we could get on a 100% mortgage, and she gets more than she can earn on bonds or cash.

2. No ceiling that I'm aware of. Plus 10% isn't really above market for some commercial loans. I'm a banker and working on a refinance now for a commercial property that is about 50% loan to value ratio. They are currently paying 10.75% to another lender.

3. The risk is that she'll default. You protect yourself by executing a formal promissory note and filing a lien against the property. This enables her to legitimately deduct the interest, and it enables you to foreclose if she can't or won't pay down the road. You don't have to worry about liability as the lender; it's her job as the owner to have proper insurance on the property, etc.

4. No, you pay regular income taxes on interest received, just as if it was a bonus or wage. She deducts it as usual as she's done in the past; the amount may just be higher.

5. The paperwork isn't a big deal. A CPA can write up a one or two page promissory note. I paid a lawyer to do them for me and my mom once and then just copied the wording myself on a Word document for subsequent loans. It's pretty simple. A lawyer would also do it for a small fee or you can even download forms online. I like a professional eye on it though just in case there are state specific clauses that have to be in there.

6. I'm not sure what state you're in but this is probably difficult to do unless you have separate assets you can lend her money from. If you are lending money from your joint assets, even if only your name is listed as lender, in a divorce he could argue that the loan is half his. Plus if you receive income from the loan while married, it's probably joint income unless you have a prenup that says otherwise (just like half your bonus or wages would be his).

One other consideration is loan structure. I would probably only do a 5 year loan term at most so that both of you have the opportunity to revisit the terms of the deal in 5 years. The amortization can be 20 years or whatever length she wants, but in order to claim the terms of the loan are regular market terms, you don't want to do something like a 30 year loan interest only at 10% or something that no bank would even consider. Interest only loans are easier to manage as far as calculating interest, but I like to have things amortize over time. Just track the payments in Excel with a standard amortization schedule (there are templates) so you can tell your CPA(s) each year how much interest was paid/received.

This isn't as crazy or weird as it sounds. If I were in your shoes I'd do it in a heartbeat. If she wants to effectively gift you funds by paying you more than market rates that's fine, but even if you were to just earn 6% I'd still do this. It's effectively a risk free return, or as close as you can get (especially if you're slated to inherit the asset anyway).
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NotWhoYouThink
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by NotWhoYouThink » Fri May 13, 2016 11:42 am

My mom wants to protect her assets from my husband. (See earlier part about not having a father present. My mom's life experience is to not trust men.) My husband is a mensch and understands completely. Is there anyway to structure a mortgage so that I'm the lender, not him, though our assets are mingled?
This would make it a deal breaker for me. You are committing your husband's savings, but planning to structure the loan so that the benefit goes to you. You are letting your mother interfere in your marital assets. No way, no how. Boundaries are good.

virginiabirdie
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by virginiabirdie » Fri May 13, 2016 8:30 pm

Wow! Thank you for reading my long post. Moreover, thank you for the awesome advice and list of things to think about.

I think it's something to keep looking into--but with your help, it's a short list. That's a change from the chaotic swirl going on in my head before I posted here. Thank you all!

We didn't really consider taxes. We are in a high bracket, but I assume we'll still come out ahead. But thanks for pointing this out!

Whew, I have some homework to do tonight.

Thank you all again!

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Re: Intra-Family Mortgage INSTEAD of Investing

Post by LeeMKE » Sat May 14, 2016 1:30 am

I know that the IRS has requirements that intra family home loans mimic conventional loan terms. When my father in law lent us money for our first home, we followed the IRS guidelines on how much interest could be charged. I'll bet those requirements apply as well to something like this.

If your tax brackets are similar, there's no reason to mess around with a side deal on a mortgage. It would be better to simply gift some cash each year. When the tax brackets are significantly different, it is tempting to fiddle a bit to move money from the high tax bracket to the lower tax bracket family unit. But maybe that's not the case with you.
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by 209south » Sat May 14, 2016 1:44 am

I recommend you reach out to National Family Mortgage, an entity that does nothing but what you are describing. I set up the inverse of the normal relationship, using money in my kids' names to loan money to me to buy a 2nd home...we are paying 3.75% (not 10%!), which was at the higher-end of market when we set it up - we get the benefit of a significant deduction at our max tax rate, and the kids pay tax at their lower rate. A good way to gradually pass liquidity to the next generation.

virginiabirdie
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by virginiabirdie » Sat May 14, 2016 6:35 am

LeeMKE wrote:If your tax brackets are similar, there's no reason to mess around with a side deal on a mortgage. It would be better to simply gift some cash each year. When the tax brackets are significantly different, it is tempting to fiddle a bit to move money from the high tax bracket to the lower tax bracket family unit. But maybe that's not the case with you.
Actually, I'm in a higher tax bracket. But I'm confused--if I earn a negative return on my taxable account now, wouldn't it better to take the deal from my mom? I know stocks go up and down, but still, 10% a year guaranteed is more likely than to turn out better than the stock market--right? I must be missing something as posters have twice mentioned the above concern.

IowaFarmBoy
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by IowaFarmBoy » Sat May 14, 2016 7:01 am

virginiabirdie wrote:
Actually, I'm in a higher tax bracket. But I'm confused--if I earn a negative return on my taxable account now, wouldn't it better to take the deal from my mom? I know stocks go up and down, but still, 10% a year guaranteed is more likely than to turn out better than the stock market--right? I must be missing something as posters have twice mentioned the above concern.
I'm not sure most of us really addressed that part of your question. If you are assuming a negative return on your investment portfolio, any stable return would be better. However, most people in this forum aren't expecting negative returns on their portfolios over the long run. If you look at the Vanguard website for the Total Stock Market Fund, an investment in it 10 years ago would nearly have doubled even with all the severe ups and downs in the market over that time. So you probably need to take a hard look at how you are investing. There is a lot of good help for that here in this forum.

That said, if I could find a very solid stable 6% return today, I would be very tempted, at least with some portion of my portfolio. As I look at this deal, I view it as 6% that is a real business cost to your mother since she is paying that already and 4% that is a gift to you with an attempt to structure it advantageously from a tax perspective. Your mother gets to write it off but you then pay tax at a higher rate. I think the point that people are making is that the extra 4% might be better handled as a gift since there are less net taxes paid.

From your side, if you had two options- one being this mortgage deal at 6% versus owning a mutual fund (assuming the same 6% return for illustration purposes although we have no guarantees what that return will be)- the tax load would be higher on the mortgage since it is taxed as regular income while the mutual fund would largely be taxed at the lower capital gains rates, possibly many years later.
Last edited by IowaFarmBoy on Sat May 14, 2016 7:27 am, edited 1 time in total.

cherijoh
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by cherijoh » Sat May 14, 2016 7:19 am

virginiabirdie wrote:
LeeMKE wrote:If your tax brackets are similar, there's no reason to mess around with a side deal on a mortgage. It would be better to simply gift some cash each year. When the tax brackets are significantly different, it is tempting to fiddle a bit to move money from the high tax bracket to the lower tax bracket family unit. But maybe that's not the case with you.
Actually, I'm in a higher tax bracket. But I'm confused--if I earn a negative return on my taxable account now, wouldn't it better to take the deal from my mom? I know stocks go up and down, but still, 10% a year guaranteed is more likely than to turn out better than the stock market--right? I must be missing something as posters have twice mentioned the above concern.
If you currently have the money you would lend your mom in cash equivalents (checking, savings, CDs) or bonds, then the comparison you are making would be valid. But keep in mind that you will need to reinvest the interest that you would receive from the mortgage. So your after-tax interest will be reinvested in something with mediocre returns.

But if you are taking about selling stocks to make this loan, then you need to consider that you may be taxed at say 33% on the interest vs. 15% on capital gains and qualified dividends. In addition, if you are in a tax efficient fund like an index fund, you can defer the taxes on the capital gains until you sell the funds many years down the road. So what ever returns you get from the stock market can compound without getting nicked each year for taxes.

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happymob
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Re: Intra-Family Mortgage INSTEAD of Investing

Post by happymob » Sat May 14, 2016 7:24 am

Fixmen wrote:While your mom could get a tax deduction, you will have to recognize it as income and pay taxes on it. You don't really come out ahead. If you're mom wants to transfer money to you, just have her give it to you as a gift. She could give you and your husband each 14k a year tax free plus another ~$5.4M over her lifetime using the unified credit.
That depends. Suppose parent is in the 28% tax bracket and child is in the 15% tax bracket. There are cases where it makes sense on paper.

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Re: Intra-Family Mortgage INSTEAD of Investing

Post by c1over8 » Sat May 14, 2016 8:49 am

virginiabirdie wrote:
LeeMKE wrote:If your tax brackets are similar, there's no reason to mess around with a side deal on a mortgage. It would be better to simply gift some cash each year. When the tax brackets are significantly different, it is tempting to fiddle a bit to move money from the high tax bracket to the lower tax bracket family unit. But maybe that's not the case with you.
Actually, I'm in a higher tax bracket. But I'm confused--if I earn a negative return on my taxable account now, wouldn't it better to take the deal from my mom? I know stocks go up and down, but still, 10% a year guaranteed is more likely than to turn out better than the stock market--right? I must be missing something as posters have twice mentioned the above concern.
So lets say that the extra 4% interest your mom is going to pay amounts to $10,000 in interest per year and if she doesn't pay it to you as interest, she can gift you $10,000.

Example where you are in a lower bracket than your mom:
Lets say you are in a 15% top tax bracket, your mom is in a 25% top tax bracket, and your mom pays you $10,000 in interest.
$1,500 is the amount of federal income tax you owe on the $10,000 of interest income
$2,500 is the amount of federal income tax your mom saved by deducting $10,000 in interest expense from her income
$1,000 is the net tax saved on the interest

So net your mom paid $7,500 and net you received $8,500. In this scenario there is a benefit to your mom paying interest instead of making a gift and getting the deduction for interest expense.

Example where you are in a higher bracket than your mom:
Lets say you are in a 25% top tax bracket, your mom is in a 15% top tax bracket, and your mom pays you $10,000 in interest.
$2,500 is the amount of federal income tax you owe on the $10,000 of interest income
$1,500 is the amount of federal income tax your mom saved by deducting $10,000 in interest expense from her income
$1,000 is the net tax owed on the interest

So net your mom net paid $8,500 and net you received $7,500. In this scenario it would be better for your mom to gift you money.

These are over simplified examples but this should give you an idea of what we are getting at.

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jimb_fromATL
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Joined: Sun Nov 10, 2013 12:00 pm
Location: Atlanta area & Piedmont Triad NC and Interstate 85 in between.

Re: Intra-Family Mortgage INSTEAD of Investing

Post by jimb_fromATL » Sat May 14, 2016 9:22 am

IMO, if your mom wants to give you money, you and she will both be better off if she just “gifts” it to you without trying to make into a fake business transaction to misrepresent her business expenses.

Aside from many other legal and mathematical reasons why it probably won't work, it makes no business sense for your mom to deliberately pay a higher than market rate of interest for her investment. The IRS will think the same thing, and will probably not allow her to claim the extra interest as a business deduction. I suspect she'd be lucky just to have to pay the extra taxes and not be fined or even prosecuted for tax fraud.

HERE is a site that explains the IRS’s view on "sham transactions"
  • "...The IRS and Sham Transactions

    A sham transaction is any business deal done without economic substance for the purpose of evading taxes. In evaluating whether a transaction is a “sham,” the IRS looks at the substance of the transaction rather than its form. When the IRS has determined that a particular transaction is a sham in its opinion, the transaction is unwound and treated as if it did not take place. The IRS will then adjust tax liability and impose interest and monetary penalties to the greatest extent possible. The IRS may also seek criminal prosecution for these sham transactions..."
jimb

avalpert
Posts: 6313
Joined: Sat Mar 22, 2008 4:58 pm

Re: Intra-Family Mortgage INSTEAD of Investing

Post by avalpert » Sat May 14, 2016 11:30 am

virginiabirdie wrote:
LeeMKE wrote:If your tax brackets are similar, there's no reason to mess around with a side deal on a mortgage. It would be better to simply gift some cash each year. When the tax brackets are significantly different, it is tempting to fiddle a bit to move money from the high tax bracket to the lower tax bracket family unit. But maybe that's not the case with you.
Actually, I'm in a higher tax bracket. But I'm confused--if I earn a negative return on my taxable account now, wouldn't it better to take the deal from my mom? I know stocks go up and down, but still, 10% a year guaranteed is more likely than to turn out better than the stock market--right? I must be missing something as posters have twice mentioned the above concern.
First, you shouldn't be earning a negative return on your taxable account over the long term - that can be fixed. Second, you aren't really getting a 10% return from your mom. At best you can say you are getting a 6% return by avoiding the interest payments to the bank (though it sounds like even that mortgage is unnecessary on your mothers part so it may not be the appropriate opportunity cost to use) and then your mother is transferring an additional 4% from the future estate to you today - and doing so in a way that, given your tax brackets, includes negative tax rate arbitrage. That is why people are saying you would be better off with her just gifting that amount to you.

VaR
Posts: 545
Joined: Sat Dec 05, 2015 11:27 pm

Re: Intra-Family Mortgage INSTEAD of Investing

Post by VaR » Sun May 15, 2016 12:58 am

I'm not going to give any advice here, but would like to share my experience of observing 100% default rates on my intra-family loans. My wife also has experienced this 100% default rate within her family.

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