Your parents are ready to move out of their house. They want to sell it to you for cheap, so they get a little cash and you get a great deal on a nice home. Sounds good, right?
Tread carefully, because this isn’t as easy as it seems. And it gets even more complicated if your parents still owe a little on their mortgage. How can you transfer ownership of the house in a way that will pay off the mortgage, provide them the proper cash for their needs and keep the money in the family?
Figure Out the Home’s Fair Market Value
First off, it’s important to know that your parents can’t gift you a home or even sell it to you super cheap without encountering huge tax headaches. In order to avoid a big tax, the house needs to be sold at near-market value. So you can’t get your parents $350,000 home for $50,000 and avoid the taxes like you would if you were buying the home at a market price.
If your parents sell the house to you for far less than that, you will still have to pay taxes on the entire fair market price of the home.
That’s why it’s important to get an appraisal, so you understand the fair market value and any accompanying tax liabilities that will crop up if they don’t sell it to you near that price.
Consider an Installment Loan
Once you know the fair market value, your parents can set the right price and sell it to you. The cheapest way for both of you to handle this may be through seller financing. That way your parents are the bank and you will pay money to them over time, offering them some cash and you the opportunity to get the home inexpensively without dealing with the banks.
First, you can factor their gift of equity into the cost as a down payment, which should be within the legal limit of what your parents are allowed to give you each year. Each of your parents is allowed to gift you $14,000 tax free every year and if you’re married, they can gift your spouse the same amount. So that totals around $60,000.
Then you need financing for the remainder of the amount. If you make an agreement directly with your parents, you’d pay them both the monthly payment and interest. For example, with a seven year installment agreement, 1/7th of the house will transfer over to you and your spouse each year. Meanwhile you would make payments including the agreed-upon interest rate. If your parents still have a mortgage, they would use the payments to pay off the remainder.
Once the mortgage is paid off, they will be pocketing the payments and the interest entirely. Instead of a traditional lender reaping the benefits of interest payments, your parents will have extra cash flow for retirement. And then if they would like, they can continue to gift you that money back each year under the tax limits.
Get a Real Estate Attorney
Once you have discussed the options with your parents, you’ll need a real estate attorney to review the plan. Try to find an attorney who is familiar with loans. Have your parents meet with the attorney to draft the purchasing agreement and partnership—you may need both.
The contract should state the sales price, amount of down payment, interest rate and monthly payments. It also designates the party that will maintain the home and pay the insurance and property taxes.
If you try to buy the house for cheap, you will have to pay taxes on the entire fair market value price of the home. Instead, an installment loan will benefit both you and your parents.
WSB Radio’s Ilyce Glink Show – July 27, 2014
Thanks for listening.