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Gifting Via Loan Forgiveness

Posted by taxguru on November 27, 2015

A very common technique for gifting large amounts of money to kids or other persons without needing to file Gift Tax returns is to loan the money to the kids and then forgive the debt in annual installments that are equivalent to the exclusion amounts.  A client was a little confused as to how this works.

From Client:

Subject: Annual Payback Note and Mortgage (Our Children)

Hi Kerry:

We loaned our kids and recorded a Real Property $140,000. Mortgage @ 2% Interest for 10 Years.  Minimum annual payment $14,000. (Equal One Gift of $14,000. to our daughter or her husband)

QUESTION:  If we gift $14,000 X 2 = $28,000. for 2015, do they in turn write back a $28,000 check plus 2% interest in 2015?  Or does time need to pass for a repayment amount? 

How will the IRS view this?  Or how do we comply with IRS laws and regulations?  You have convinced me that that IRS Clerk sitting behind that desk may be unable to get a family loan and for sure not receive a dollar gift each year. She may have grounded her experiences in a chick flick void of real life stuff. Plus she may have a Bill Clinton definition of "is". Yes Sherry, it’s a woman! (haha) Men are nice:).

The $140 K mortgage is established in our Quick Books.  I will need to calculate the exact amount of daily interest at the time the kids pay.

Appearing simple is why there is fear and trepidation.  Plus, I’ve learned it’s the little things that will get you.

Being Very Cautious

 

My Reply:

While using actual money back and forth is possible and would give a good audit trail, that is not how this is normally handled.

While not the only way to handle this, normally the donors (you and your wife) give the recipients (your daughter  & her husband) a Gift Letter that announces that you have forgiven a certain amount of the principal of the loan, and then show what the new balance of the loan is.

This can be posted into QB just like a monetary transaction.  In your QB, you would use the General Journal to debit the Gift expense account and credit the Loan Receivable account.
 
In the QB for the kids, they would make a similar entry; a credit to the Gift Income account and a debit to the loan’s liability account.

For the interest you are charging, that would be cleaner all around if it were handled with a check from the kids to you and your wife.  They can deduct it as home mortgage interest on their Schedule A and you would report it as interest income on your Schedule B.

The annual tax return free gift exclusion for 2015 and 2016 is $14,000 per donor per donee and is calculated on a calendar year basis (Jan 1 to Dec 31).  Depending how much you want to gift, you and your wife are allowed to each gift up to $14,000 to each other person without needing to file any Gift Tax returns.  That actually works out to as much as $56,000 per year for you two to gift to your daughter and her husband.  You don’t have to gift that much, but it’s more than the $28,000 figure you were using in your question.

There is no time delay required for the first Gift Letter.  If you haven’t already used up your $14,000 allowance for 2015, you can make that gift any time before the end of the day on December 31, 2015.  You can then make the second Gift Letter as of January 1, 2016 because that would be in a new calendar year.  Obviously, the earlier you make the gift, the less interest you will be charging them.

In another year or two, the annual exclusion will be bumped up to $15,000.  It only goes up in $1,000 increments when the cumulative inflation factor is high enough. You will then be able to gift up to $60,000 per year to them.

I hope I haven’t made this too confusing for you.  Let me know if you want to discuss any aspect of this on the phone.

Kerry

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