“For many Americans, owning a home is an essential part of the American dream that conveys a number of economic benefits, such as the ability to accumulate wealth and access credit by building home equity, reduce housing costs through the mortgage interest deduction, and gain long-term savings over the cost of renting.”[1]
However, according to a 2021 survey conducted by the Pew Research Center, 70% of Americans say that young adults have a harder time buying a home than those in their parents’ generation.[2] The same survey found a large difference in opinion between age groups when it comes to the ability to purchase a home. Among the age groups illustrated, most agreed that buying a home is harder for today’s young adults than those in their parents’ generation. This difficulty is felt most acutely by young adults themselves, with 84% of those surveyed believing that they have it harder than their parents’ generation did when it comes to buying a home.[3] There are many different philosophies when it comes to children and money. A 2019 study found that many parents in the United States said that they helped their children financially in the preceding 12 months.[4] In the same study, “some 45% of adults ages 18 to 29 (with at least one living parent) said they have received a lot of or some financial help from their parents in the past 12 months.” [5]
Parents do help their children, and many desire to help their children purchase homes, particularly that all-important first home. There are many ways to provide such help. Nevertheless, because each family, and its financial circumstances, is unique, there is no one strategy that works for every family, and each different strategy comes with its own legal, tax and financial considerations. Before assisting a child with the purchase of a residence, you should consult with your legal, tax and financial advisors to determine which strategy works best for you and your family. In the end there is no substitute for careful analysis.
Chart 1: When it comes to savings, paying for college and home-buying, most say young adults today have it harder than their parents’ generation
% of U.S. adults saying each of the following is __ for young adults today compared with their parents’ generation
Note: Share of respondents who didn’t offer an answer not shown.
Source: Survey of U.S. adults conducted Oct. 18-24, 2021.
PEW RESEARCH CENTER
View accessible version of this chart.
Chart 2: Views about whether young adults have it harder today differ significantly by age, especially when it comes to buying a home and finding a job
% of U.S. adults saying each of the following is harder for young adults today compared with their parents’ generation, by age
Source: Survey of U.S. adults conducted Oct. 18-24, 2021.
PEW RESEARCH CENTER
View accessible version of this chart.
The Whole Thing
For parents with significant wealth, it may be possible to simply give your child sufficient funds to purchase a home. For calendar year 2022, each U.S. citizen and resident has an exclusion from the gift and estate tax of $12.06 million (for a married couple, $24.12 million). Parents can make gifts up to the amount of their unused exclusion without paying gift tax.[6]
Of course, before making any large gift, parents should prepare an updated financial plan to determine if such a gift would negatively impact their other financial goals and objectives.
Making a large gift to a child, however, may not be desirable for many reasons. Perhaps making such a gift would negatively impact the parents’ retirement plan or, when it comes to home ownership, parents would like the child to have some “skin in the game.” In that case, parents could consider lending the child money to purchase a home.
Parents with significant wealth may be able lend the entire purchase price to a child. The terms of the loan can be more attractive than those obtained from commercial lenders. Interest rates can be as low as the applicable federal rate (AFR).[7] Payment terms can be flexible. For example, consider a child who recently graduated from medical school with some amount of student loan debt, is newly married and has a desire to own a home. Although the child may have significant student debt payments, the child’s future earning capacity may be significant. The parents could structure a loan to the child allowing for the payment of interest only for the first 5 or 10 years of the loan, with the balance amortizable over the remaining term of the loan, perhaps 20 or more years.
Lending money also has tax consequences. The interest you receive from your child is income and should be included on your income tax return for the year the interest is received.[8]
The Internal Revenue Service (IRS) presumes intrafamily loans are gifts.[9] This presumption can be overcome by the way the loan is structured and paid. If there is an expectation that the loan will be repaid, there is a written promissory note, the loan bears adequate interest, the loan is secured by collateral and there is a fixed repayment schedule, the loan is more likely to be respected as bona fide debt and not treated as a gift.[10] If the parties do not respect the terms of the transaction (for example, even if the loan is properly documented, no payments are made on the loan) the IRS may nevertheless treat the transfer of funds from the parent to the child as a gift rather than a loan.
Securing the loan with a mortgage recorded with the appropriate government office can also help the borrower. One of the requirements to deduct interest on debt used to purchase a residence is that the debt be secured by the residence. [11] Therefore, while securing the loan with a mortgage can help show that the loan is a bona fide , it can also satisfy one of the requirements that would allow the child to deduct the interest on the loan for income tax purposes. [12]
Something Less than the Whole Thing
For many reasons, parents may not desire to fully fund a child’s purchase of a home, but nevertheless want to assist the child with home ownership. There are many possible ways to do this.
Sometimes a child needs just the down payment with the balance of the purchase price being provided from a commercial lender. Perhaps the child just needs a “little bit more,” which when added to what the child has saved, will provide an adequate down payment. Parents can help here too.
Certain small gifts are excluded from the gift tax. An old legal maxim states that the law does not concern itself with trifles.[13] To prevent the need for donors (and the government) to keep track of small gifts (like holiday and wedding presents), [14] donors are permitted to give up to $16,000 (known as the annual exclusion amount) per year to any number of recipients without having to file a gift tax return. To qualify for the “annual exclusion,” the gift must be of a “present interest in property.” A present interest in property is one that the beneficiary can access and use immediately.[15] This means that two parents can give a child up to $32,000 each year without having to pay gift tax (or having to use any gift tax exclusion). [16] Perhaps, such a gift is just what is needed to provide down payment that will enable the child to obtain a commercial mortgage. A note of caution is in order here. As part of the mortgage application process, some lenders will want to know the source of the down payment. If parents make a gift to the child that will be used as the down payment for the purchase of the home, the parents may be required to provide a gift affidavit to the lender, indicating that those funds were, indeed, a gift and will not be repaid. If you expect those funds to be repaid, you should not sign a gift affidavit. Making a false statement under oath can have serious legal consequences, including criminal penalties.
Gifts can also be used to help a child support mortgage payments. Usually, this occurs due to some hardship, such as the loss of a job, as reputable commercial lenders are unlikely to make a loan to a person without sufficient income to service the debt. In fact, in 2019 about one-third of parents said that they helped a child to make mortgage or rental payments in the preceding 12 months.[17]
Annual gifting can also help reduce a loan balance. If the child has a commercial mortgage, the child can apply the gifts to reduce the outstanding principal value. This strategy can be employed even if the parents are the lenders. For instance, parents can lessen a child’s debt burden by forgiving (from time to time) some of the interest and principal due to them. For example, each year the parents could forgive unpaid interest and principal on the debt up to their remaining annual exclusion amount without having to pay gift tax (or use their lifetime exclusion amount).
It may also be possible to lend your child funds to help with the purchase of a residence. While this is not possible in all cases, some commercial lenders may allow you to lend money to your child secured by the residence, so long as your debt is subordinate to theirs. This means that in the event of a default, the commercial lender is paid before the parents.
Other Mechanisms
Parents may consider co-signing a mortgage loan for a child. In essence the parents are lending their good credit to assist the child. Nevertheless, this can be a risky proposition for the parents, because if the child fails to pay the mortgage the parents become liable for the entire loan. Before co-signing any loan document, the parents should understand whether they are primarily or secondarily liable for payment. Generally, if both the child and parents are primarily liable for payment, the lender can expect payment from any of them and can proceed against the parents for payment directly; if the parents are secondarily liable for repayment, the child must default before the lender can proceed against the parents.
Parents could also guarantee a child’s loan. In that event, the parents agree to pay the loan should the child default on the obligation. Some lenders may also accept additional collateral pledged by the parents to help secure the child’s debt.
Although not without controversy, it is possible that parents who co-sign or guarantee a loan for a child or pledge their personal assets as additional collateral for a child’s debt without being paid therefor may have made a gift to the child equal to the value of the promise.[18]. Parents should consult with their personal tax advisors with respect to this possibility.
Parents should understand the risk they are undertaking when promising to pay a child’s debt. By agreeing to pay the full debt (either primarily or secondarily) the parents put their own cash flow and assets at risk should they be called upon to repay the debt. Further, co-signing a loan or providing a personal guarantee for a child’s debt could impact the parents’ credit rating, and, perhaps, hinder them from borrowing for their own lifestyle needs.
The law with respect to promissory notes, co-signors and guarantors can vary from state to state. Parents should seek legal advice with respect to their rights and responsibilities and the taxation of the transaction before signing any document in connection with a child’s purchase of a home.
More Complicated Structures
If parents have created trusts for their children (or if grandparents have created such trusts), depending on the terms of the trust, it may be possible for the child to borrow from the trust. In that case, the trustee would determine if lending trust funds to the child to enable the child to purchase a home is in the best interests of the trust and all of its beneficiaries.
Alternatively, a trust for the benefit of a child may have terms that allow it to purchase a residence for the child and allow the child to live in the residence rent free. If parents or grandparents have previously created such a trust for the child, and the trust has sufficient assets, perhaps the trust could purchase and own the home, allowing the child to reside in the home rent free.
If the trust does not already have terms like those described above, it may be possible to modify an existing trust to add them. Depending on the state law governing the trust, it may be possible to modify the trust through judicial modification (when a court changes the terms of a trust), non-judicial settlement (when the beneficiaries and trustees agree to change the terms of a trust) and decanting (when the trustee exercises a power in its discretion to distribute the trust to another trust).
Raising Cash
Parents who are fully invested may not have sufficient cash on hand to help their child purchase a residence. Of course, the parents can raise cash by selling assets. However, selling assets can create capital gains and cause an income tax. Borrowing can provide liquidity for those who are fully invested but want to assist family members financially. Consider a parent who is fully invested in illiquid or appreciated assets yet wants to assist a child with the purchase of a residence. Rather than liquidate appreciated or appreciating investment assets and incurring a capital gains tax, the parent could borrow cash secured by those assets and relend that cash to the child.
Parents should understand the financial impact of borrowing and relending. For instance, if the interest charged on the parents’ loan is greater than the interest received from the child, the parents will have negative interest arbitrage. That is, the parents will pay more than they receive. For parents with sufficiently large estates, this may be a price worth paying, as they will have assisted their child in purchasing a residence, preserved their existing portfolio and asset allocation and may reduce the size of their estates and future estate tax liability. Additionally, subject to limitations, the parents may be able to deduct the interest paid on their debt as investment interest.[19]
Do the Analysis
There are many ways to help a child purchase a home. Nevertheless, before engaging in any financial transaction of this type, it is important to do the analysis. Parents should understand the legal and tax consequences of any transaction.
As you think about helping your children purchase homes, consult with PNC Private Bank® Wealth Strategist, who can prepare an updated financial plan illustrating the potential impact such a transaction will have on your personal financial goals and objectives. Your PNC Private Bank team stands ready to work with you, your attorney and accountant to create a plan that can help your children achieve the dream of home ownership and also fit your financial goals and objectives.
TEXT VERSION OF CHARTS
Chart 1: When it comes to savings, paying for college and home-buying, most say young adults today have it harder than their parents’ generation (view image)
| Harder | Easier | About the Same | |
|---|---|---|---|
| Saving for the future | 72 | 11 | 17 |
| Paying for college | 71 | 14 | 15 |
| Buying a home | 70 | 16 | 14 |
| Finding a spouse or partner | 46 | 21 | 32 |
| Finding a job | 39 | 40 | 21 |
| Getting into college | 33 | 41 | 26 |
| Staying in touch with friends and family | 14 | 74 | 12 |
Chart 2: Views about whether young adults have it harder today differ significantly by age, especially when it comes to buying a home and finding a job (view image)
| Ages 18–29 | Ages 30–49 | Ages 50+ | Youngest/Oldest Difference | |
|---|---|---|---|---|
| Buying a home | 84 | 72 | 63 | +21 |
| Saving for the future | 80 | 74 | 67 | +13 |
| Paying for college | 80 | 72 | 66 | +14 |
| Finding a job | 55 | 39 | 33 | +22 |
| Finding a spouse or pranter | 52 | 47 | 42 | +10 |
| Getting into college | 45 | 34 | 27 | +18 |
| Staying in touch with friends and family | 16 | 14 | 13 | +3 |
