Thank you for your questions covering a wide range of topics. Your first question of gifting money to your daughter from the sale of the house and her using the funds as a downpayment is really two distinct questions:
- What are the tax implications for you if you gift money to your daughter?
- What are lender’s requirements for the source of downpayment?
You last question, regarding a wraparound mortgage, is an interesting question about an infrequently used technique to offer lender financing to the buyer.
Tax Implications of Gifting Money
In general, the IRS permits non-taxable gifts to third parties. As of 2012, you are allowed to gift $13,000 without paying taxes or declaring the gift in your income tax statement. A married couple can each gift the $13,000, so that they gift to one person $26,000. Gifts can be in the form of money or personal property, whose value is determined by using IRS rule.
The IRS allows for certain exemptions to the gifting rules, including payments made on the behalf of a third party to an educational or medical institution to cover tuition or medical expenses, or gifts to charities and political organizations.
If you gift to an individual more than the $13,000, then you must declare the sum to the IRS, using IRS Form 709 (PDF). However, that does not mean you must pay taxes. Using the unified credit to gift tax, you can avoid paying taxes on the excess up to a cumulative (carry over from past years) sum of $1,772,800. Any sum you credit will be deducted from the allowable exemption amount allowed for your estate tax.
Whenever you are giving away large sums of money, make sure that you refer to IRS Publication 950 and speak to a tax professional and/or estate lawyer to properly plan and report your gifts.
Gift Money for Downpayment on House Purchase
The second part of your question relates to gift money as a source of downpayment and closing costs. In general, lenders require that the borrower show proof of having enough funds to cover the downpayment, required reserves and closing costs. This is referred to as a “minimum borrower contribution.”
Conventional loans, such as Fannie Mae or Freddie Mac backed loan require that the lender verify the existence of funds to cover the minimum borrower contribution, as well as the source of the funds. Asset verification varies depending on the type of funds available. The lender is required to check depository accounts for a two- to three-month period. It is possible that monies gifted sufficiently before the time of application will not require gifting verification and documentation.
For many types of loans, there is no problem in using gift money. This includes principal residences and second home, but usually not investment properties. There are exceptions, such as high balance loans where Fannie Mae requires a minimum amount of non-gift money. There are also additional rules if the donor is a domestic partner. If the donor is connected to the transaction (the builder, seller, real estate agent), then gift money is not allowed.
The lender will want to see:
- Proof of the existence of the funds.
- Verification of how the funds were transferred.
- A gift letter.
Make sure that you prepare, in advance, a gift letter, following these steps, as explained by Fannie Mae’s selling guide, The gift letter must:
- “specify the dollar amount of the gift;
- “specify the date the funds were transferred;
- “include the donor’s statement that no repayment is expected; and
- “indicate the donor’s name, address, telephone number, and relationship to the borrower.”
Before you transfer any funds, check with your loan officer about the requirements for your specific loan.
Your last question deals with a non-conventional manner of structuring the sale of your property. I am not sure why you are investigating this option, as you start by mentioning that you want to gift money from the sale of your house. Is your mortgage interest rate that significantly less than today’s market? Will you be getting enough cash from the sell?
A wraparound mortgage works like this:
- You maintain your mortgage on the property.
- You transfer title of the property to your seller against a small cash payment and registration. (This will be subject to your title and mortgage).
- You register a mortgage under the seller’s rights.
The obvious advantage to the wrap-around mortgage is that you make money on the spread between your low-interest-rate mortgage and the higher rate you charge the buyer. However, there are risks involved including these three:
- Most loans are not assumable. If that is the case with your mortgage loan, then you will be in breach of the “due on sale” clause, which requires you to repay the loan upon sale of the property.
- Can the buyer afford to make the payments? Although you are protected if the buyer defaults, you are still responsible for the payments on the mortgage listed in your name. If the property values drop, then it is more likely that the buyer will walk away from the property leaving you with an underwater mortgage.
- Making the payment arrangements may be complicated. Since you are not a mortgage lender or servicer, you may have trouble making payment arrangements. You want to make sure that you continue to make your mortgage payments on time. Remember, you are responsible for the loan and any late payments will show up on your credit report and hurt your credit score. If you are relying on the borrower’s payments to you to cover your mortgage, then you are at a high risk. It is possible that the borrower will want to make payments directly to your mortgage servicer or through a third party that divides the sum between your lender and yourself.
Basically, wraparound mortgages are a high-risk loan. If your buyer is putting a small downpayment and/or can’t qualify for a conventional loan at the lower interest rate, then that is an indication of a high-risk borrower. Wrap around mortgages are particularly attractive in a market that has higher interest rates (so you have a spread) and rising housing prices (to reduce your risks of being left with an underwater property).
Before you consider such a loan, consult with an attorney who specializes in real estate and financial transactions.
I hope this information helps you Find. Learn & Save.