If you are considering contributing to or investing in the purchase of a first home for one of your children, having finished college and embarked on a career and family, you should consider a Shared Equity Financing Agreement pursuant to Internal Revenue Code §280A. Why not let the IRS contribute $5000.00 per month to purchase a new home for your kids?
Both the occupying owners and the non-occupying owners are put on title in the percentages that they contribute towards the cash portion of the purchase price. Typically, that means the occupants own 1% and the non-occupants own 99%
The occupants "rent" the non-occupants' interest for its reasonable market value. Paper the file with rent ads from the newspaper. Rents are always less than the sum of debt service, property taxes, and fire insurance. Plus the IRS will allow the rent to be discounted, both because a family member is taking care of the property for the non-occupants and because you can always collect from family members, since they tend to stay in touch, at least to some degree. So the rent can be less than the carrying costs. This allows you to subsidize their home without using up any of your annual estate and gift tax exclusion.
Plus, here's where it gets interesting, since you are a landlord, you can deduct expenses that a homeowner cannot. Fire insurance is not deductible by a homeowner, but it is by a landlord. Landscaping and swimming pool services are not deductible by a homeowner, but are by a landlord. Same with utilities. Just add all those items into the responsibilities for payment by the landlord, and increase the rent to cover them, less whatever you want to subsidize the occupants.
The non-occupant landlord can deduct depreciation. It's only a little over 3% (1/27.5 years), but it's one more deduction against your other income. If the house costs $500,000.00, the depreciable improvements are probably 80% or $400,000.00. Divide that by 27.5 years and you have an annual depreciation deduction of $14,545.45. Assuming your marginal tax rate is 35%, that deduction represents $5,090.90 in tax savings. Your tax preparer might increase this deduction by separating out parts of the house, like the roof, furnace, water heater, and appliances and depreciating them at faster rates.
Compare this with lending the kids the $100,000.00 downpayment and gifting them the interest and some portion of the downpayment each year. Use up part of your annual gift tax exclusion versus more than $5000.00 in reductions of your taxes paid every year.
The entire transaction must be structured in a way that you will make a profit. The IRS has not defined what "profit" means. Let's say you set up the rent and deductions so that you break even from the rental operation. Then on the sale of the property, you should make a small profit. In past transactions, we made it CPI or half of CPI. CPI was up near 10% per annum in those days. Now that it is 3%, I think the kids can afford the full CPI. Historically, housing values has appreciated faster than CPI. Even with CPI increases the kids will acquire some appreciation even when they refinance and buy out Mom and Dad.
Please allow Dana Sack to help you set up such a Shared Equity Financing Agreement and let the government pay part of the cost of your kids' new home.