Q: In a recent column, you advised a reader, who had lost his job and could no longer make payments on the family home, not to panic. You said he should sell an interest in the home to his daughter, who could then take over the mortgage payments. Is that really the correct advice? Couldn't the couple and their daughter have come up with something else?
A: Howard Gordon, a Palm Springs, Calif., certified public accountant, offers a couple of ideas. But before detailing them, let's review the facts of the couple's case.
The husband has lost his job, and the couple can no longer make the $2,000 monthly payments on their $190,000 mortgage. The house, which was purchased for $30,000 and remodeled at a cost of $100,000, has a market value of $600,000.
The couple's daughter is willing to take over the mortgage payments but would like to be able to claim a mortgage interest deduction. The couple is willing to deed her a portion of the house for taking over their payments.
Mr. Gordon's first suggestion is that the couple sell the house to their daughter on an installment basis, with the initial one-third installment consisting of the $190,000 value of the mortgage she is taking over.
This deal gives the couple a taxable gain of $60,000, which Mr. Gordon figured by deducting the $130,000 basis in the house (the $30,000 initial cost plus the $100,000 remodeling cost) from the $190,000 value of the mortgage the couple is no longer responsible for.
Mr. Gordon estimates that the couple will have to pay income taxes of $12,000 to $15,000 on the gain, even though no cash changes hands.
This, of course, could require the couple to dip into their savings to make the payment. Although they could opt to use their one-time exclusion of $125,000 in home-sale profit, Mr. Gordon says they would be better off saving the exemption for when they complete the installment sale and face a tax bite on the remaining $410,000.
Meanwhile, Mr. Gordon says, the daughter can treat her parents' house as her second home and take the interest deduction allowed for second-home mortgages. She should also pay her parents' interest on the $410,000 remaining on the purchase. She can deduct those payments as well.
However, the couple must declare the interest payments on the $410,000 as income. Another key point, Mr. Gordon says, is that the couple do not have to pay rent to their daughter, nor does the daughter have to declare the foregone rent as an imputed gift since rent is not required.
Mr. Gordon's alternative plan calls for the couple to sell the house to the daughter for the full $600,000. They take no money down and extend a $600,000 "wrap" mortgage to the daughter at an interest rate of, perhaps, 7 percent.
The daughter pays her parents $3,500 per month interest on the note, from which they make their monthly mortgage payment of $2,000.
The daughter gets a tax deduction for the $3,500 mortgage payment, and the parents keep their $2,000 monthly mortgage payment deduction as well.
Although the couple is liable for taxes on the full $3,500 as income, they could gift back a portion of it -- up to a maximum of $20,000 per year -- to the daughter to enable her to meet the steep $3,500 monthly payments.
In this scenario, the couple is not liable for taxes on the sale of the home until the daughter pays off the principal of the loan.
The sale could be canceled or foreclosed before the principal is paid should the couple work their way out of their financial bind.