What to Know Before Buying a Home for Someone Else

What to Know Before Buying a Home for Someone Else

Have you ever considered buying a home for someone else? Maybe you’d like to give a head start to an adult child, take care of an elderly parent, or help out someone with bad credit or who is simply having a hard time financially. It’s a noble idea and it can be done. But there are things you need to know so your generosity doesn’t end up costing you more than you expected.

Buying a house is an investment that comes with legal and financial responsibilities. Buying a second house might be more than you can handle. Let’s look at the different ways you can manage the transaction, and the pros and cons. 

Giving a House as a Gift

If someone has the financial means to afford it, they may choose to give a home—paid in full—as a gift. Or, perhaps, they are in possession of a second home that they could sell or rent out but decide to make it a gift to someone instead. All the owner needs to do is sign over the deed of a house to the parent, child, or whomever they wish.

Once the house is in the occupant’s name, it belongs to them completely. They take on all of the tax liability, upkeep, and legal responsibility that comes along with the property. They can also do whatever they wish with the home, even sell it. 

Someone who decides to gift a house in this way needs to understand this. The new owners could make changes that the purchaser does not approve of or allow the property to fall into disrepair, and have every right to do so. If the giver wants to maintain some control of the property, making an outright gift may not be the wisest choice.

There are also tax implications for the giver of this type of gift. Individuals are allowed to give gifts of up to $15,000 to as many people as they want. A married couple can give $30,000. Since a house will exceed that amount, the giver will need to file an additional form (Form 709) with their income tax return. Taxes won’t be due on the gift unless a lifetime exclusion of $11.58 million (doubled for married couples) is reached. (These are the current rates for 2020.) 

Most people will not reach the lifetime exclusion amount unless they can afford to gift several grandchildren with cars, college tuition, and houses. But filing additional tax returns can be a nuisance and is something they need to know about and be prepared to do.

Getting a Second Mortgage

Buying a second home with cash is probably beyond most people’s financial ability. Instead, they may decide to get a second mortgage. Second homes usually pose more risk for banks, so they may be reluctant to lend the money. Obviously, the buyer needs a great credit score and a hefty downpayment, and they might pay higher fees and interest rates. 

The borrower can keep their name on the house and let their loved one live there. Their name stays on the deed, so they keep their rights as owners of the property. They can make any improvements or changes they wish, and decide to sell it if they want to. It also means they can continue to take the tax breaks for the mortgage interest and property taxes.

But it also means they take on all of the responsibilities. In addition to the home where they live, they will need to pay the second home’s mortgage payments, property taxes, insurance, and upkeep. They may have an arrangement with the occupant for them to take on some of the costs and labor involved. For example, the parents may pay the mortgage and taxes, but the adult children living in the house pay the utilities and any maintenance or repairs.

All of these things are ultimately the owner’s problem, though, if the occupants do not hold up their end of the bargain. The agreement could be written up in a legal contract, but few people want to take their family members to court. Lending to friends or family members—in this case lending them a place to live—can cause conflict and ruin relationships when things don’t go as planned. It’s important for all parties to know what they’re getting into.

Sharing Ownership

generations in front of a house co-ownership of house

A third option when buying a home for someone else to live in is to share ownership and split the rights and responsibilities. By co-signing on a mortgage, both names will be on the deed. This can be in an equal 50/50 split or some other agreed-upon percentage. This can work for some people but has its drawbacks.

On the plus side, the combined assets of both parties may make it easier to borrow from a lender. Or, together they may be able to afford a bigger or better house than either could on their own. 

Sharing ownership, unfortunately, combines the bad as well as the good. The transaction will affect both parties’ credit. Buying a home can be a boost for a credit score, provided payments are made on time. In fact, helping a child establish a good credit rating can be a motivation for a parent to co-sign for a mortgage. But if one co-owner does not pay their share, both credit scores will suffer.

Many people might successfully co-sign for a house, but there are plenty of horror stories where it simply doesn’t work out. If one party defaults, the other is stuck with the property and all of the costs and responsibilities.

Other Ways to Buy a Home for Someone Else

Gifting ownership, keeping ownership, and sharing ownership are three basic ways of buying a home for someone else to live in. Since no two relationships are alike, there are several different ways people can structure the agreement to make it work for their situation.

Gift the Downpayment

Gifting only the downpayment for a property can give the occupant the financial boost they need to get a house, without getting involved in its ownership. If the amount of the downpayment is below the IRS threshold, the giver may even be able to avoid having to claim the gift on their tax return. 

This, of course, assumes that the occupant is otherwise able to get financing on their own. Different types of loans have strict guidelines about how much of a downpayment can be gifted. Lenders frown on anything that could look like an off-the-books loan rather than a gift, so it is best to check on the rules before handing over the cash. In fact, giving cash gifts long before the loan process begins might be the best way to avoid any problems with getting a mortgage. For example, a gift given to a child a year ago is now their money, rather than a contribution to their downpayment. 

Gift Partial Interest

The owner of a property can give gifts that gradually give the occupant ownership. For example, a parent could give their child a 5% interest in a house each year until the child owns 100%. This keeps the parent in control of the property and the mortgage until the halfway point when the child owns the majority interest. 

While this might sound like the best of both worlds—the child is both invested and protected—it comes with some complications. If the percentage exceeds the gift-giving limit, the parent will need to file a gift tax return. More importantly, an appraisal will need to be done on the property to assess the exact value of the home. This may be a cost and bother that an owner might want to avoid.

Charge Rent

An owner can buy a house for someone else and charge them rent. It’s important to note that calling the purchase an investment property will typically result in even stricter restrictions from a lender than a second home, particularly in the amount of the downpayment. It is common for them to require at least a 20% deposit.

The amount of rent that is charged is an important detail. If the amount is the market rate, the owner essentially becomes a landlord. The rent is considered income, but they can claim all of the tax deductions that renting out a property entails

But if only a nominal amount of rent is charged, the IRS will consider the house a personal use asset, and any landlord benefits will not apply. Charging below the market rate, or allowing someone to live rent-free also ends up counting as a gift, and Form 709 must be filed.

Claim as Dependents

One way that a person can live rent-free is to claim them as a dependent. The IRS will only allow this if the homeowner is also responsible for at least half of their living expenses. This is an extreme solution with a lot of legal and financial ramifications, but it might be a practical option for an elderly or disabled relative. It should not be considered without first seeking the advice of an attorney.

Do Your Homework Before Buying a Home for Someone Else

The financial and legal details of buying a home for someone else can be complicated and hard to undo if you change your mind. And family issues can be fraught with emotions, blame, and guilt. 

Before deciding to show your generosity in this way, be sure you know what you’re getting into. Discuss your plans with a lawyer and accountant. And if you decide to move forward, contact Berkshire Hathaway HomeServices Select Properties. Our agents can help find the property that’s right for you and your loved ones.

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