Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, June 14, 1993 TAG: 9306140035
SECTION: BUSINESS PAGE: 6 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Medium
Plenty of houses are on the local market, their prices kept stable by slow inflation.
Now, to borrow the usual sales pitch from the real estate industry, could be the perfect time to buy a house.
"Before rates climb and inflation takes off, first-time home buyers should explore every option to take advantage of the current favorable conditions," said J. Patrick Budd, a certified public accountant with the Roanoke firm of Budd, Ammen & Co.
But what of young people who lack the cash for a down payment?
Should they be locked out even though they qualify for mortgages where the monthly payments may be even lower than their rent?
The typical answer is to borrow the money from parents.
Budd said this generally isn't a good idea for the parents, who may need the cash or the income from the money if it's invested, especially in a pension plan.
The Internal Revenue Code may provide a way out of that quandary, Budd said, through a Shared Equity Financing Arrangement.
Under this plan, parents usually come up with the down payment and closing costs while their adult children take on responsibility for monthly mortgage payments.
Parents share ownership in the home to the extent of their contribution.
Budd said this arrangement is especially useful for parents who cannot afford a gift, or for some other reason do not want to make one.
The parents' net worth is unchanged under this plan because they have traded one investment for another - real estate.
By charging rent for their share of the house, moreover, they replace income that would have flowed from a certificate of deposit or other investment.
Meanwhile, their children occupy the house and receive the tax deductions and financial benefits of home ownership.
The parents also receive tax benefits - plus the potential appreciation of rental property.
Budd said the rental income is taxable to the parents to the extent that it exceeds any monthly expenses paid by the parents.
But because this is rental property, the parents can deduct any cost of insurance, maintenance, utilities and depreciation in addition to the normal interest and real estate taxes.
The parents would be entitled to their share of the proceeds if the property is sold, Budd said. But a more practical approach is for the children to buy out the parents when the house is sold or when they can afford it, he said.
If there is a profit at the time of sale, Budd said, the parents would receive a capital gain while the children probably would opt to defer their gain by rolling it over into a more expensive home.
Budd cited three options for parents who want to help their children own a home:
The easiest way is a gift of the money needed to qualify for a loan.
Each parent can give up to $20,000 to each child - a total of $40,000 for a child plus his or her spouse - without adversely affecting their estate and without incurring any gift taxes.
Another method is a loan to the children.
Budd said this is not as effective as a direct gift since the overall amount of the debt and repayment terms of the loan come into play in the process of the children's qualifying for a mortgage.
Under this scenario, the parents should secure the debt with a second deed of trust on the property.
This document will ensure that the loan by the parents is secured by the house if the arrangement doesn't go as planned. A divorce of married children would be such a factor.
It has the added benefit of making interest paid on the loan tax-deductible for the children.
A third option is for the parents to co-sign or guarantee the home mortgage.
If they follow that course, the parents become responsible for the full loan in the event the children cannot pay and default on it.
Besides shouldering the the debt in the event of a default, this method can become a problem if the parents need to borrow money for other purposes and their interest in the mortgage shows as a contingent liability on their personal financial statement.
The loan would also become problematic if married children get a divorce.
Finally, the guarantee could be considered a gift.
Budd said parents and children considering any of these arrangements should contact a certified public accountant, lawyer or banker to determine which option best suits their particular situation.
A professional should also draft the Shared Equity Financing Agreement to ensure that it meets all requirements of the Internal Revenue Code.
"This window of opportunity in affordable home ownership is rare for current times," Budd said.
"I would advise you to explore all options before conditions change."
by CNB