Silent interest-free loan to buy home -- tax consequences?

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Safire

Recycles dryer sheets
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Hi,

My brother is offering us an interest-free "silent" 10-yr loan to buy our first home -- we are both in California. There is no written repayment agreement although we have a verbal agreement to pay him back with in 10 years with the funds in our IRA accounts (which we could then access without taxes and penalties).

1. What - if any tax consequences - will we both face under these circumstances if he is neither on the title nor on the mortgage?

2. Will the lender have questions or need a written undertaking from my brother that no repayment will be required in the next 10 years?

3. Should we cut just one single check to the seller at closing or should we send two checks ? My brother does not want to "mingle" funds as he is concerned of the potential tax consequences of receiving a large sum from us, even if it will be immediately re-routed via a downpayment check to seller at closing. Do you see any potential pitfalls with this? Or is it better to produce two checks at closing?

Finally,

5. Will my brother or I owe any taxes if - at the end of the 10 years - he does "forgive" the loan or does not accept my repayment (as he has hinted he MAY if we are still living in the property and the home is in a trust for my son? Will Uncle Sam and California each want a "cut"? How does this work? TIA

​

 
# 2 above mentions a lender, so I assume this loan from your brother is for the down payment?

If yes, your primary lender, the mortgagee, is likely going to require a "gift letter" from your brother to explain the funds in your account, unless he gives you the money well in advance of the closing. It's been a while, but I think banks look back many months, as many as 6, for proof of down payment funds. a sudden influx of money needs to be explained.

# 3 typically the title company or closing attorney will issue the checks or process the wire transfers. It's a question for the bank, and the lawyers, on how they want to receive funds.

#5 depends on if this is a gift, or really a loan. gifts can be tax free, forgiveness of dept is a taxable transaction to the borrower (as income) and potentially lost income (bad debt) to the lender.

to # 1, i can't imagine any tax issues, but I don't think what you've described is formally a "loan" and is going to need to be treated as a gift.
 
1. To the IRS, there's no such thing as an interest free loan. If they find out about this loan, they will calculate interest at the Applicable Federal Rate and impute that amount to your brother as taxable income. California will also treat the imputed interest as taxable income because your CA tax return is based on your Federal return.

2. The primary lender will almost certainly need a legal statement from your brother regarding this loan. They may require a promissory note and a second mortgage, or they may require that he certify it's a gift with no strings or repayment expectations in the future. You need to ask them about their policy; nobody else can know what it is.

3. All parties will contribute funds directly to the escrow account and the escrow company will pay the seller. It doesn't matter whether your brother gives you the money and you send the money to escrow or if you give him the money and he sends it to escrow or if you each give your own share of money to escrow. The IRS doesn't care about who moves money around. Most likely, nobody is going to write a check to anybody else though. Money for home purchases in California is normally moved around by wire transfer.

4. ?

5. If he forgives the loan at the end of 10 years, then that's a gift to you. He has to file a gift tax return if the amount of the gift is greater than the exclusion amount in that year (currently $18K per person). He won't owe any tax until the total amount he's given away is greater than the lifetime exclusion (currently $13.6M). When he dies his lifetime exclusion is reduced by the total amount reported on gift tax returns during his life. There are no Federal tax consequences to you as the recipient of a gift. There are no California tax consequences to anyone with a gift.
 
If you give enough to have to file a gift tax return that would be subtracted from the max when settling your estate, do you need to keep track and maybe record it along with your will or does the IRS keep track and somehow reconcile when the time comes?
 
Safire said:
There is no written repayment agreement although we have a verbal agreement to pay him back with in 10 years with the funds in our IRA accounts (which we could then access without taxes and penalties).
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Won't you IRA withdraws be taxed, or are they Roth IRAs? Also, if they are taxed, won't a big withdraw push you into higher tax bracket(s) once your ready to repay your brother in 10 years?
 
joesxm3 said:
If you give enough to have to file a gift tax return that would be subtracted from the max when settling your estate, do you need to keep track and maybe record it along with your will or does the IRS keep track and somehow reconcile when the time comes?
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From Form 706 Estate Tax Return:

8 a Have federal gift tax returns ever been filed? . . . . . . . . . . . . . . . . . . . . . . . . .
If “Yes,” attach copies of the returns, if available, and furnish the following information.
b Period(s) covered c Internal Revenue office(s) where filed

I would think that most people who are affected by Federal estate tax have an accountant do their taxes and that person would also have done the prior gift tax returns or at least received them in a handover. If not, then yes, you should keep them with your will and other estate docs just in case your executor needs to file an estate tax return.
 
Your brother needs to charge you interest on the loan. This is under IRS rules. The interest will need to be filed as income for your brother.

If this is a gift from your brother, he will need to fill out the gift form because it is over $18K per person.

I helped my son pay for his home outright. He paid 1/3rd of it from his savings and I paid the remaining 2/3rd. Since it was a cash purchase, the seller/developer needed a letter from me to declare that I would pay the other 2/3rd in cash and provide a bank/brokerage statement to show that I had the money. My son also had to present proof of his 1/3rd cash in his account.

Subsequently, I filed the gift form to IRS. There is no tax consequence.
 
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Apologies to @Cathie63 and all the other CPAs that get upset when I ask a question like this, but "OP, what is the probability that you or your brother will get audited in a way that would discover this transaction? Near zero, I'll bet." And if lightening strikes, you are just civilians faced with 21 volumes of IRS regulations. How could you possibly know? Apologize, pay any taxes due, and hope that they will waive penalties.
 
Don't do this..the fact you need to do this means you can't afford the home...
 
To be legal your brother could gift you the downpayment.

Then 10 years later you could gift the money back to your brother, if he is still alive or expresses a desire to want some $$$.

That way it's not a loan, and no IRS loan rules. Each would need to fill out the gift form for the IRS.

I will say this suggests you cannot afford the home and is risky due to this basically zero down route.
 
Well, am a CPA and I do not get upset at the question.... heck, I had a BIL who always asked that question when I gave him tax advice.. but guess what? He got audited!!! Now, it was much worse than something like this as he failed to send in the money withheld from his employees... they REALLY do not like that...

BTW, they ignored all the minor stuff he did so he did get away with some things...
 
OldShooter said:
Apologies to @Cathie63 and all the other CPAs that get upset when I ask a question like this, but "OP, what is the probability that you or your brother will get audited in a way that would discover this transaction? Near zero, I'll bet." And if lightening strikes, you are just civilians faced with 21 volumes of IRS regulations. How could you possibly know? Apologize, pay any taxes due, and hope that they will waive penalties.
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Just to be clear, I am not a CPA. I am also not upset if people want to assess their chances of getting audited when deciding whether or not to obey the law.
 
cathy63 said:
Just to be clear, I am not a CPA. I am also not upset if people want to assess their chances of getting audited when deciding whether or not to obey the law.
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+1. I always obey the law. Heck, I sold 2 multi-million dollar homes overseas and reported capital gains tax on them and paid hundreds of thousands of dollars in capital gains. You know what, I sleep so much better at night. My friends asked how would they know and that I was silly to part ways with so much money. When I transferred money to the US, they would know.
 
Also remember that NOT reporting income can be considered fraud and does not have a statue of limitations... they have to prove fraud so there is that...

Here is the time periods you need to be aware if playing IRS audit roulette...


Period of limitations for assessment of tax:​


3 years - For assessment of tax you owe, this period is generally 3 years from the date you filed the return. Returns filed before the due date are treated as filed on the due date.


No limit - There's no period of limitations to assess tax when you file a fraudulent return or when you don't file a return.


6 years - If you don't report income that you should have reported, and it's more than 25% of the gross income shown on the return, or it’s attributable to foreign financial assets and is more than $5,000, the time to assess tax is 6 years from the date you filed the return.
 
Sunset said:
To be legal your brother could gift you the downpayment.

Then 10 years later you could gift the money back to your brother, if he is still alive or expresses a desire to want some $$$.

That way it's not a loan, and no IRS loan rules. Each would need to fill out the gift form for the IRS.

I will say this suggests you cannot afford the home and is risky due to this basically zero down route.
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If the IRS got "wind" of this gifting back and forth, they might say that it was a actually a loan and subsequent repayment in "disguise." At that point they might insist upon "interest" with appropriate taxes. Now, I have no special insight on this stuff, but the IRS seems to have its own sense of "morality" about such things from what I have seen. Clearly, YMMV.
 
Koolau said:
If the IRS got "wind" of this gifting back and forth, they might say that it was a actually a loan and subsequent repayment in "disguise." At that point they might insist upon "interest" with appropriate taxes. Now, I have no special insight on this stuff, but the IRS seems to have its own sense of "morality" about such things from what I have seen. Clearly, YMMV.
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Absolutely if anything was written down it would be a loan, and without anything written down it could easily cause family disagreements.
As I was writing it, I thought someone would bring up the issue of how it could be construed as structuring a transaction to avoid taxes.
 
SecondCor521 said:
By reading @cathy63's reply in post #3, as well as the other replies on this thread.

Or by asking their competent tax preparer.

Or by reading the IRS website.
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Quite funny. You miss my point completely. " How could you possibly know?" is the plea to the IRS guy if you get audited.

Risk management involves probabilities and impacts. In this case I see a near zero probability and a relatively minor impact. Not reporting the gain on sale of a major asset may be low probability of detection but is definitely not minor impact. Not paying employee tax withholding fails both tests.
 
RetiredHappy said:
+1. I always obey the law. Heck, I sold 2 multi-million dollar homes overseas and reported capital gains tax on them and paid hundreds of thousands of dollars in capital gains. You know what, I sleep so much better at night. My friends asked how would they know and that I was silly to part ways with so much money. When I transferred money to the US, they would know.
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I was in Canada and used their bank machine to withdraw ~$8,000 from a local bank where I had an account.
The next day I drove across the border into the USA.
For the first time in 25 years, the customs fellow asked me how much money I had on me !!
I was pretty impressed with the rapid flow of information, or perhaps it was simply incredible random chance.
Since then, I've not been asked, but I've not carried so much over the border either.
 
I have a girlfriend who sold her million dollar property overseas and did not report the sale/profit. Each year she would tranfer under $10K into the US. She also travelled back to see her family with her husband and they would each carry about $9K back to the US. She did not want to pay taxes on the sale of the property but it is sure a tedious way to get money back to the US. If she takes 30 years to get money into the the US, I think she could get maybe half a million dollars back. The rest will be in her estate and through that, I think she could avoid taxes after her death.
 
OldShooter said:
Quite funny. You miss my point completely. " How could you possibly know?" is the plea to the IRS guy if you get audited.

Risk management involves probabilities and impacts. In this case I see a near zero probability and a relatively minor impact. Not reporting the gain on sale of a major asset may be low probability of detection but is definitely not minor impact. Not paying employee tax withholding fails both tests.
Click to expand...

I understood your point completely. Perhaps you missed mine: Pleading ignorance when one is not ignorant is lying. It's also federal perjury, which google says can carry $250K fine and 5 years in prison. To your point in post #22, that's worse in my book than speeding, which is a state level infraction with a moderate fine.

I'm not sure how often it gets used, but there is an IRS whistleblower program where the IRS will pay folks 15% of the recovered taxes to the whistleblower. So if you're going to cheat on your taxes and commit perjury, make sure that your kids / spouse / ex-spouse / friends / coworkers don't find out about it either. This is an additional way to get caught aside from an IRS audit.
 
As you like. Our opinions differ on the subject. Happens all the time. No big deal.
 
RetiredHappy said:
I have a girlfriend who sold her million dollar property overseas and did not report the sale/profit. Each year she would tranfer under $10K into the US. She also travelled back to see her family with her husband and they would each carry about $9K back to the US. She did not want to pay taxes on the sale of the property but it is sure a tedious way to get money back to the US. If she takes 30 years to get money into the the US, I think she could get maybe half a million dollars back. The rest will be in her estate and through that, I think she could avoid taxes after her death.
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Lots of folks get screwed as they don't know the $10K rule.
Cross the border with $10,001 USD equivalent currency without declaring it immediately (before asked anything) and it is subject to seizure, and it does get seized.

I think a drug dealer will have lots more than $10K, and the limit seems small since inflation has eroded the value.
 
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