If your parents loan you money...

behaviorkeltonSeptember 25, 2007

Instead of having a mortgage, let's say I borrow from my parents... so they simply give me the money on a handshake to pay back the loan.

Now, I'm just giving you a hypothetical...let's not get bent out of shape.

So I promise to pay the loan back to them at, say, 5.5% yearly.

1. Is this legal?

2. Would my parents have to report the 5.5% interest as income? (could they keep the full 5.5%?)

3. Is there a system in place that could detect such a "deal". (-a-there is a sudden 100,000 drop in my parent's bank account. -b- the parents are depositing 2,000 monthly back into their account)

I've got no idea. Any answers?

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The following answers are to the best of my knowledge, which might be incorrect. If you really care, you should check with an expert.

1) Yes.

2) They are supposed to report it.

3) In principle, the answer is yes. I believe that all banking transactions larger than a few thousand dollars are reported to the IRS, so they would have all the information they need. In practice, I would guess that such a deal would be detected only if one of the parties involved happened to be selected for an audit, which is unlikely but far from impossible. I would also think that the chance of getting caught would go up if you tried to deduct the interest payments from your taxes, as your tax return would then have to report who received the payments.

    Bookmark   September 25, 2007 at 10:32AM
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Well, even with my current mortgage rate of 6.1%, it doesn't even meet the criterion for a deduction... it's lower than my standard deduction.

    Bookmark   September 25, 2007 at 10:48AM
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I can answer #3. At least this was true 5 years ago. A bank had to report any transaction over $10,000. Believe me, if your account suddenly had a large deposit, the Feds would be aware of it. Ditto a large withdrawal from your parents account.

They are looking for money launderers (usually from drug deals) - that's what the bank told me.

Yes, your parents need to report the income as interest income.
You could deduct the interest, but if you were audited, you'd need to have proof. So if you have a written agreement, you could have an annual statement of interest from your parents.

Now, your parents could "gift" you - but the amount is limited (I THINK) to $10,000. You wouldn't have to report the "gift". If you had a verbal agreement to pay it back with interest, they would not need to report the interest, but you couldn't deduct it either.

    Bookmark   September 25, 2007 at 10:49AM
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The "gifting" limit is $12,000 per year. However, each parent can gift $12k without reporting, making the sum to the giftee $24k. And the double gifting - someone correct me if I'm wrong - has to come either from a joint account or from each parent having separate accounts. If your father, say, is sole owner of the account - he couldn't gift 24k and say 12k is from your mother.

Yes, and deposits of more than $9,999.99 are still held by the bank for a few business days to do whatever reporting and/or checking they do - and you don't have access to the new deposit amount during that time. Generally you wouldn't notice this unless your account is continually spent down to the last dollar.

In effect, it's unlikely you can get away scott-free from reporting any kind of unusual internal family deals and it's usually because one or more of the participants makes a mistake - somebody is going to pay if being creative goes outside the norm.

    Bookmark   September 25, 2007 at 11:57AM
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Somehow, it just doesn't seem right to meddle in the affairs between parents and their offspring.
Oh well. Thanks for the input.
I was thinking that it would be cool to borrow from parents such that:
1. The child gets a good interest rate.
2. The parent gets a good interest rate! (5.5% isn't bad if you truly get to keep all of the interest)

    Bookmark   September 25, 2007 at 1:44PM
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We have done this...we paid market interest and reported ours to the IRS for the deduction and parents reported the interest received as income. There is a rule about the interest rate, I don't know exactly how it works but if the rate is too far below market the government will look at the loan as a gift and that changes the tax consequences. We felt that our savings on closing costs and having that loan held by a family member were a big enough benefit and wanted to make it a 'win/win' by paying a decent interest rate.

    Bookmark   September 25, 2007 at 2:36PM
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1- Yes, done all the time.
2- Absolutely, its reportable income. The fact that you're a family member has no consequence. In fact if they charge no interest, there is an imputed interest rate.
3- Not really. What the above posters left out was that the tracking they are talking about is cash transaction greater then 10k. The fact that they write a check to you for $100k and you deposit the check triggers no automated reporting. However, just because there is no system to keep everyone honest, like a 1099, it is still no excuse to not follow the law. The IRS vigorously pursues the maximum penalties when they catch people that do not report income on their tax returns.

The best advice would be to hire a tax advisor to help you structure the loan to legally minimize the tax effect on all parties.

    Bookmark   September 26, 2007 at 12:39AM
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You may wish to read the link below to get a better understanding of family gifting. Many people do not understand the gift tax is cumulative, and no tax is triggered until the total gifts exceed the lifetime exclusion benefit (which changes year to year, until 2010 when Congress must decide whether to re-install the estate tax AKA "death tax", modify it, or eliminate it).

If your parents' estate is under $2M this year and you are the sole heir, that is the total lifetime amount they can gift to you without triggering taxes. Again, I emphasize this life changes every year, so it's wise to keep an eye on this going forward, particularly if you are NOT the only heir (so your proportion of the overall estate will limit the total lifetime gift amount).

Per the IRS website:
"If you give someone money or property during your life, you may be subject to federal gift tax. The money and property you own when you die (your estate) may be subject to federal estate tax. The purpose of this web page is to give you a general understanding of when these taxes apply and when they do not. It explains how much money or property you can give away during your lifetime or leave to your heirs at your death before any tax will be owed.

Most gifts are not subject to the gift tax and most estates are not subject to the estate tax. (Only about 2% of all estates are subject to the estate tax).

Generally, you do not need to file a gift tax return unless you give someone, other than your spouse, money or property worth more than the annual exclusion ($11,000 in 2002, 2003, 2004 and 2005; $12,000 beginning in 2006) for that year. Although a return may be required, no actual gift tax will become payable until the cumulative lifetime taxable gifts exceed the applicable exclusion amount. The donor is primarily responsible for the payment of the Gift Tax.

To reemphasize: Most relatively simple estates (cash, publicly traded securities, small amounts of other, easily valued assets and no special deductions or elections or jointly held property) with a total value under $1,000,000 and a date of death in 2002 or 2003, under $1,500,000 and a date of death in 2004 or 2005, and under $2,000,000 and a date of death in 2006 or 2007 do not require the filing of an estate tax return. "

Here is a link that might be useful: Gift tax and estate tax explanation

    Bookmark   September 26, 2007 at 11:18AM
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I don't think they will be in trouble if no one reports them. I have an acquaintance who reported someone not declaring their income correctly and found out that they would be audited also. Boy were they sorry. We didn't charge our children interest on any loan they asked for, but in some cases I would think a minor interest would be a beneficial to the child as a step into the real world. I would never charge them the going rate.

    Bookmark   September 26, 2007 at 12:12PM
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Chemocurl zn5b/6a Indiana

Just kind of thinking out loud here....

They loan you the money interest free...

Could you maybe first pay off the 'loan', and then either save the amount of the interest, or borrow it, and then 'gift it' to them....for making you an interest free loan.

Legal? Silly? I know in families a lot of things are just based on trust....no binding legal agreement.


    Bookmark   September 26, 2007 at 2:19PM
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My late FIL had his estate thought out and the accounts in place years before his death. We were allowed to "borrow" the money in the account for a portion of our home. We were told it had to be repaid at a fixed rate of interest (that accounted for the rate it would have gained in very safe investment account) for a fixed amount of time. We took full advantage of it! we paid back every single dime in a timely manner. We were accorded a tremendous amount of equity initially, but we were wise enough to understand that paying the loan back was actually an investment in our FUTURE. And we maximized our personal savings at the same time. In short, we worked our asses off, went without, "made due", and grumbled the way everyone else does.

I still remember my FIL's words... "why should you have to wait for me to die to avail yourselves of what I have intended my son inherit? you should be rewarded for responsibility at the time of your life when you're most able to earn it and young enough to ENJOY it.".

He was a "tough cookie" but he was kind, fair, and generous. And he was smart enough to know that giving "10 fingers" was the best way to pass on wealth and imbue the giftee with a sense of responsibility. My parents were not nearly as far thinking, sadly! And yet their "means" was comparable.

    Bookmark   September 26, 2007 at 3:11PM
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Hi again chelone,

The idea of giving "10 fingers" is unfamiliar to me.

What does it mean, please?

Does it mean, "Giving someone a hand" X 2?

Good wishes for a fine weekend.

ole joyful

    Bookmark   February 9, 2008 at 6:36AM
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A clarification .. since 9/11 banks are required to submit a SAR (Suspicious Activity Report)for transactions $10,000 or more, especially if that transaction is not "normal" for that account. The SAR is reported to the government, it is not only for money laundering for drugs, it is also to make sure terrorists are not transfering money.

    Bookmark   February 9, 2008 at 5:33PM
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Maybe its just me, but draw up a loan doc

Report the income
report the expense
be done with it

Unless its a gift, then its a gift.

    Bookmark   February 11, 2008 at 8:57PM
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One of the problems of not documenting a loan to a family member occurs when the lender dies before the loan is repaid. A friend's father loaned $100,000+ to his brother but the loan wasn't documented. My friend has no legal claim for repayment of the "handshake" loan. Luckily, his father told him about it. He hopes that his uncle will eventually pay him but there is no remedy if his uncle chooses not to repay. Also, what happens if my friend's uncle dies?

    Bookmark   February 12, 2008 at 3:55AM
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Several years ago, I borrowed $12,000 from my mother to buy a car. She sent me a check. I paid her back $1,000 a month for a year. After the loan was repaid, I bought her an expensive set of dishes as a "thank-you". We never did anything with IRS.

    Bookmark   February 13, 2008 at 8:44AM
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