How to Help Your Children Buy a Home

Brian Lamborne is a senior director of Advanced Planning at Northwestern Mutual.

The red-hot housing market may be cooling somewhat, but with mortgage rates rising and prices still at lofty levels, many young people looking to buy a home find themselves turning to a traditional source of funding: the Bank of Mom and Dad.

If you’re looking to help your children buy a home, options abound. While everyone’s situation is unique, we’ll look at the pros and cons of some common options to help you get a sense of what might work best for your situation.

Option 1: You pay for the home outright

This approach is the most straightforward if Mom and Dad have sufficient funds. Parents simply give their child the full purchase price of a home. That is likely to trigger significant tax consequences. While the child will pay no income tax on the gift — gifts are not considered taxable income for the recipient — the parents likely will have to consider gift taxes.

Currently, the law provides an annual gift tax exclusion of $16,000, which means that anyone can give up to $16,000 per year to anyone else without any gift tax considerations. It also means that parents jointly can gift up to $32,000 to any one person. If their child is married, parents can give up to $64,000 a year to the couple without any gift-tax consequences. Any gifts above those annual limits start to reduce each parent’s lifetime gift-tax exemption of $12.06 million ($24.12 million combined). That exemption will drop to approximately $6.3 million per person ($12.6 for a married couple) at the end of 2025 unless tax laws change.

If gifts exceed the annual exclusion, the amount must be reported on a Form 709 gift tax return, even if no gift taxes will be paid that year. The Internal Revenue Service determines if any gift taxes are owed when a person’s estate tax return is filed.

Let’s assume the parents buy a $1 million home for their child and his/her spouse. In this hypothetical case, the parents would see their lifetime exemption reduced by $934,000 (the $1 million gift minus the $64,000 in annual exclusions). After buying the home — assuming they had made no other large gifts in the past that exceeded their annual exclusion — the parents’ lifetime exclusion would be slightly more than $23 million.

Pros:

• The child owns the home free and clear.
• Purchasing a home with cash is often faster than taking out a mortgage and may induce the seller to lower the price.
• Without having to pay off a mortgage, the child’s monthly housing expenses are reduced.

Cons:

• The gift reduces the parents’ investable assets.
• The child may forgo the ability to deduct the mortgage interest.

Option 2: You help pay for part of the home’s cost

Parents can gift a child cash for the down payment, contribute to paying home expenses on an ongoing basis or do both in any combination. For tax purposes, any gifts the parents make would be subject to the same limits and tax treatment as outlined above.

Parents may also consider being a co-signer on the mortgage. In this case, parents are not considered co-owners, but guarantee they will pay the mortgage if their child doesn’t, potentially allowing their children to get a mortgage they may not otherwise have been able to.

Pros:

• With their parents’ help, a child may be able to purchase a more expensive home than they might otherwise be able to afford.
• The child owns the home and begins to build equity.
• The child should be able to deduct the cost of mortgage interest.

Cons:

• Depending on the size of the gifts, there may be gift tax consequences to the parents as discussed above.
• Parents’ may be entering into a long-term financial commitment and will be on the hook financially if their children don’t pay.

Option 3: You buy a home and rent it to your child

In this scenario, parents don’t buy a home for their child, but buy it themselves as an investment and rent it to their child.

This alternative, which can provide a child with a reasonably priced place to live, may work well under certain circumstances. Parents with a child in college or living somewhere for a relatively short time may find that owning an apartment or a home for a few years may make more sense financially than paying their child’s rent or having the child buy a home with money that is a gift.

A parental purchase also may be a good choice if parents benefit more from the tax breaks of owning investment real estate than their child might from owning the same home. The benefits of investment real estate include being able to deduct the cost of property taxes, mortgage interest, maintenance and depreciation. But for expenses to be deductible, the property owner must report income, which means charging rent.

If a child pays below-market rent or doesn’t pay rent at all, any difference between what the child pays and market-rate rent may be considered a gift. In such cases, the gift tax rules and limits would apply.

Pros:

• Parents may profit from an investment in real estate and potentially take advantage of its tax benefits.
• The child’s living accommodations are likely to be better than what they could afford on their own and perhaps less expensive than if parents paid the child’s rent.
• The child doesn’t have the responsibility of home ownership.
• By paying low or no rent, a child may be able to begin saving for a down payment for a future home.

Cons:

• The child doesn’t own a home.
• Parents take on the responsibility of investment property ownership and management. 

Option 4: You loan the money to your children

In this scenario, the children don’t go to the bank for a loan, rather the parents provided the necessary funds to allow their child to buy the home.  

If the parents have sufficient funds, they can lend the money to their children and agree to terms that are better than would be available through a bank.  The parents and child enter into an agreement with terms they have agreed to, allowing the child to use the money borrowed to purchase the home.  The parents can secure the note with the home and the child then makes payments to their parents in accordance with the terms of the note.  In the event the child can’t make a payment or are struggling, the parents could defer or forgive the payments, allowing the children to avoid foreclosure.  In addition, by securing their interests with the home, the parents can protect themselves from potential unforeseen events.  Lastly, the parents have the ability to forgive the note, allowing the child to stop making payments on the note.    

Note that, if the terms of the note are not subject to market rates, any difference between what the child pays and market-rates may be considered a gift. In addition, forgiving the note will be considered a gift from the parents to the child.  In such cases, the gift tax rules and limits would apply.

Pros:

• The child will be the owner of the home and begin to build equity.
• The terms of the note may be more friendly than terms provided by a bank.
• The parents can protect themselves from potential unforeseen events by securing the property. 
• The parents may be able to forgive or defer payments in the event the child is struggling, allowing the child to keep their home.  
• The parents will receive interest income.

Cons:

• If the child decides not to make payments on the note, the parents may be forced to choose between foreclosing on the property or gifting it to their child, creating potential strife. 
• Taxes will be owed on the interest income received by the parents.

Bottom Line

No matter how you do it, helping a child with a home can be a great way to help them build wealth. If you’re interested in helping your child buy a home, have an open conversation and be clear about any expectations. It’s also a good idea to discuss any plans with your financial advisor and to consult with an attorney and tax advisor before making any final decisions.

This publication is not intended as legal or tax advice. Consult with a tax professional for tax advice that is specific to your situation. Northwestern Mutual Financial Representatives do not render tax advice.