Whether it’s a primary residence or an investment property, buying real estate is a monumental moment in your life. It takes planning, mental preparation, and, last but not least, cash. Often, the cash piece is what holds people back from buying.
However, it shouldn’t because there are many options out there. One option is gift money from a family member or a very generous friend.
There’s a lot of confusion around whether or not you can receive gift money and what tax implications it has. The fact is, as long as you plan accordingly, it’s pretty simple.
Based on the IRS rules for gift money, you can gift someone up to $17,000 per year with a total amount of up to 12.92 million for their lifetime. However, as long as you’re staying at or under the $17,000 per year as a gift, that doesn’t eat into the 12.92 mil lifetime exemption.
For example, James’ parents gift him $17,000 annually from the time he is born until he’s 21. That equals a total of $357,000. Lucky James!
However, his parents can still gift James up to 12.92 million as a lump sum because they stayed within the yearly gift limit.
Fast forward to James as a 25-year-old adult, and he wants to buy his first house.
For this example, let’s say his parents didn’t gift James money yearly. As is the problem with many young adults looking to buy their first home, he doesn’t have enough money for his down payment. Mom and Dad to the rescue!
Example:
Sale Price: $500,000
Down Payment: $100,000 (gift money from Parents)
Closing Costs: $13,000 (gift money from Parents)
Interest Rate: 6.5%
Taxes: $4,900
HOA: $90 monthly
Monthly Payment: $3,100
In the example above, James is putting 20% down, which isn’t necessary to buy a primary residence. He could have put as little as 3.5% down. However, Mom and Dad wanted to help him and ensure his monthly payment was within his budget.
Their total gift ended up being $113,000. The only stipulation is that the $113,000 would be subtracted from the lifetime exemption of 12.92 million. Because it was over the $17,000 yearly exemption.
This type of gift is totally acceptable and is done all the time. However, it must be done within the guidelines that James’ lender requires. It needs to be gifted within a specific timeline, and you need to be able to show where the funds came from.
Another “gift” option would be for James to get a loan from his parents instead of the bank.
In this case, instead of gifting James the money for the down payment, his parents would loan him the money to cover the total cost of the property. They would have the option to provide the loan at what is called Applicable Federal Rate (AFR), which is significantly lower than the rate you will get from a bank.
Example:
Sales Price: $500,000
Down Payment: 0 (James is going to borrow $500,000 from his parents)
Closing Costs: $13,000 (Technically, he’ll be borrowing $513,000 since he’ll roll the closing costs into the loan)
Interest Rate: 3.84% (AFR set by IRS for long-term loans)
Taxes: $4,900
HOA: $90 monthly
Monthly Payment: $2,450
In this case, it’s a more significant cash outlay for James’ parents. However, the lower interest rate creates a much smaller monthly payment for James. It also doesn’t eat into the lifetime gift exemption of 12.92 million.
Gift money is just one of the many creative ways to buy real estate. If you’re fortunate enough to be in either of the positions above, it should be considered when buying a primary residence or investment property.
As always, I highly suggest you discuss this with your accountant, lender, and estate attorney before making any moves.
