Other Planned Gifting

While gifting strategies can involve millions of dollars and extensive family businesses, they can also take a much smaller form, allowing parents to make gifts to children to assist in the purchase of a home or other investment opportunities. Coupled with intra-family lending strategies it is even possible to greatly exceed the annual gifting limits.

Eric and Fran have two children, Georgia and Haley, with whom they are very close. Circumstances had led to the daughters, along with their husbands, living a significant distance from Eric and Fran. A significant factor in this situation was the high cost of property near Eric and Fran’s home, keeping the daughters in their young marriages from affording to live closer to their parents. Eric and Fran had done fairly well for themselves and have the flexibility to assist their children, but want to do so in a way that does not completely provide the daughters and their husbands with a handout. 

Through a series of discussions with us, each other, and a realtor, Eric and Fran located a large parcel of land for sale in an area that was centrally located for all three families. They then proposed that if the daughters and their husbands were willing to build a home on the property, Eric and Fran would purchase the land and divide it into three parcels so that the family could all be close together. This land division would take the form of a gift where Eric and Fran would each give each of their daughters and each husband a gift of interest in the land on December 31st and January 1st of the following year. This complex gift allowed Eric and Fran to each give $14,000 of value to each of their daughters ($28,000 from both parents together) plus the same amount to each son-in-law. They then repeated the gift the next day so that within the span of twenty-four hours Eric and Fran had effectively gifted $112,000 in land to each of their children. 

While this initial gift allowed Eric and Fran to bring their family back together, it was only half of the plan they eventually put into place. Once Georgia, Haley, and their husbands owned the land, there was still the matter of building houses. After working with builders and architects to create designs for all three homes, construction was set to commence.  Instead of funding the construction with a standard building loan, Eric and Fran had the means to loan each of their daughters the cost of construction. They did this much like a normal loan, documenting the whole process and including with the loan a mortgage on the property and residence, which insured that Eric and Fran would be repaid, and gave them a priority lien on the property in the event their daughters ever found themselves in financial dire straits. 

A significant benefit of this intra-family loan was the ability for Eric and Fran to use the IRS’s Applicable Federal Rate (AFR) as the interest rate for the loans, instead of using a standard bank rate. While bank rates at the time were relatively low, the AFR for a short-term (under three years) intra-family loan was under 1% annually. This allowed Eric and Fran to establish loans to their daughters that would save the daughters thousands of dollars in interest payments over the lifetime of the loan. The monthly loan payments were amortized over a normal 30-year period with a balloon payment at the end of three years, the intention being that the loans be “refinanced” at the three-year mark to pay the balloon payment and every three years thereafter to continue to take advantage of the very low short-term AFR. 

While all of these steps provided a great benefit to Georgia and Haley, Eric and Fran wanted to build in one more benefit to their daughters (and their sons-in-law). Each year after the creation of the loans, if each couple made all of their required payments on time and in full, Eric and Fran would make additional “gifts” to reduce the principal of the loan. These gifts are always less than the annual exclusion and therefore will never impact the couple’s lifetime exemption. Eric and Fran also like the idea that the future gifts are discretionary (and not guaranteed or required) and that they are not simply handing their daughters money that they will not fully appreciate. If Georgia, Haley, and their husbands follow through with their obligations in full (and Eric and Fran continue to make annual gifts), they will enjoy fully paid off homes in a burgeoning Michigan community in less than ten years, a significant advantage and one that will not incur any gift tax liability for anyone involved. 

We cannot state enough that this and every other strategy we discuss in this blog involve complex planning and should not be attempting without consulting experienced attorneys and other advisors to ensure that expensive errors to not occur. 

Matt and Al