Buying a home for your child doesn’t have to stifle their development, hurt your relationship with them or harm your net worth.
“Buying a home for your child can accomplish a number of things,” says Terry Ruhe, regional trust manager for U.S. Bank Wealth Management. “If handled properly, it can help them develop a greater sense of responsibility, and it can be a portfolio diversifier for you.”
Below are four reasons why it can be a good idea.
1. Invest in your child’s self-sufficiency.
For many high net worth families, the cost of a house usually isn’t an issue. However, conflict can arise in how this type of purchase meshes with your values. Does a home for your child help develop character or instill dependency?
“Buying a home for your child can help them develop a greater sense of responsibility, and it can be a portfolio diversifier for you.”
- Terry Ruhe, regional trust manager for U.S. Bank Wealth Management
Ruhe says that when handled correctly, it can be a positive move. “If you take the idea of investing in your child a step further by purchasing a home, you can create a sense of responsibility by requiring them to pay rent or utilities and to care for the home to help teach them about managing a household and being accountable,” he says. “Considering your child an unrelated ‘tenant’ enables all sides to reap benefit. In other words, aim to handle the transaction objectively.”
Because your family members’ needs change over time, agree upfront on ground rules to avoid future conflict. For example, consider drawing up a lease for your child, to make sure all responsibilities and home agreements are legally recorded and upheld, and consider the consequences if they aren’t. Taking a security deposit from your child may help you make sure that the terms of any lease or agreement are maintained.
2. Take advantage of the gift tax.
You can also consider making a home an outright gift. This could be an advance on a child’s inheritance, allowing you to take advantage of the current federal tax exclusion on gifts and estates.
Currently, each parent may give a gift to a child of up to $12.06 million under the gift tax lifetime exemption before the funds are subject to federal taxation. As tax rules are subject to change, you should consult with your tax advisor before making a gift and consider any state estate taxes that may apply.
3. Reap the benefits of price appreciation and rental income.
If your child is struggling to land on their feet financially or they need a place to live during college or grad school, you might consider buying a property and allowing them to live there rent free, Ruhe says. You should speak with your tax advisor on potential gift tax implications if you allow your child to live in the home without paying rent.
After your child moves on, you can consider keeping the property and take advantage of potential long-term appreciation and opportunities to earn rental income. If you rent out the property, not only will you get a stream of (taxable) income, but you may also be able to deduct expenses like repairs, mortgage interest, utilities, and depreciation. But remember, when you sell a renter-occupied property, you’re less likely to qualify for a capital-gains tax exemption.
4. Utilize an irrevocable trust.
You also have another option to invest in your child: Rather than buying a home in your name for your child, you can place it in a family trust, with children among the named beneficiaries. This may potentially save estate taxes. Aside from this, a trust could be a tool to enable a child to purchase a home. This could be done in several ways:
- A child could receive an outright distribution
- Trust assets might be used as collateral on a loan to the child outside the trust
- A loan could be made from the trust
“The trust options might be helpful in situations where the child does not otherwise qualify for a conventional mortgage,” says Ruhe.
Another option is a Qualified Personal Residence Trust (QPRT). This involves transferring or gifting a home into a trust for a limited time and your child owning the home once the QPRT expires.
“A QPRT reduces transfer taxes when compared with an outright gift due to the donor’s ‘use’ period,” says Ruhe. “The idea is to freeze the value of the residence when it’s originally contributed to the trust, which will hopefully result in significant tax savings over time.”
If you use a QPRT, you have the option of leasing the home back from the child (if they no longer live there) when they receive the home at the end of the trust’s term. You can then live in the home and lease it at fair market value.
Discussing the details of your QPRT before the trust term ends should, ideally, prevent any misunderstandings between you and your child.
Overall, if you’re considering buying a house for your child as an investment, it’s important to think big picture, both financially and personally. Your investment should work financially within the constraints of your portfolio, but it also needs to be in the best interest of your child and your relationship with them.
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