The purchase of a home is a significant financial event, especially for the first time. In the Bay Area, homes can be prohibitively expensive. Without family help, first time buyers can be priced out of the market. There are several tools that wealthy parents or grandparents can use to assist a younger generation accomplish their goal of owing their own home. Below, we describe one such approach that involves phased gifting, which enables a young buyer to purchase a home at a price point that may otherwise be out of reach.

For this example, we will consider a young buyer looking to purchase a home with a $1,600,000 price point.

Phase One: Annual Gifting

This first phase begins well in advance of the identification of a property. Per the IRS, any person may gift another individual $19,000 per year (calendar year 2026 amount). This amount, called the annual gift exclusion, is an irrevocable gift and does not incur a tax to either the individual making the gift or to the recipient.

By utilizing this annual gift exclusion, each parent, grandparent and others can gift $19,000 to minor children or young adults. If these gifts are ongoing, the funds that accumulate can become substantial. Nelson Capital, in coordination with estate planning counsel, often recommends that parents consider establishing an irrevocable trust, especially for minors, that utilize a “Crummey right” to create a present interest.

Example: Wife and husband establish an irrevocable trust for the benefit of their 16-year-old child. Every year, they gift $19,000 each ($38,000 total) to this trust. When the child turns 25 years old, the parents have accumulated $380,000 in gifted value (10 years x $38,000), plus any portfolio return, to a trust for the benefit of their child. The assets held within the irrevocable trust can be utilized for a wide range of uses. The accumulated funds can be used to help the child for purchase a home, start a business and or pay for higher education. If the funds remain unused, the trust would ultimately dissolve and be distributed to the child for their discretionary use.

Phase Two: Home Purchase

When the buyer is ready to purchase a home, the funds in the irrevocable trust can be used as a down payment. In some cases, the accumulated funds may be enough support to accomplish the home purchase goal. As home prices have increased, even with down payment help, many children will still need parental help to qualify for a loan. They can get this help by asking mom or dad to cosign on a bank loan. This presents an additional gifting opportunity. In our example, the child has identified a home to purchase with their spouse for $1,600,000. The irrevocable trust has accumulated $400,000 (gift value plus appreciation). In agreement with the terms of the irrevocable trust, the funds are released to assist with a home purchase. The parents could offer to match the $400,000 and then co-sign on a loan of $800,000 for example. This allows the joint purchase of the home as “tenants in common”.

Home Purchase Price: $1,600,000

FUND SOURCES:
Child’s contribution from trust distribution: $400,000 (25.0%)
Parents’ contribution from personal assets: $400,000 (25.0%)
Parents’ participation as cosigners of loan: $800,000 (50.0%)

At this point it is recommended that the child and parents draft and enter into a tenants in common agreement (“TIC”). A TIC stipulates the ownership of the property, identifies which party is responsible for making the mortgage payments, taxes and ongoing maintenance. The agreement can stipulate, for example, that the mortgage is carried by the child, increasing the ownership attributable to the child. Parents can still utilize the annual gift exclusion ($19,000 per parent) to help the child with the ongoing mortgage payments, if necessary.

In this example, if the child is identified as the mortgage owner, the ownership of the new home would be split 75% to the child and 25% to the parents.

CHILD‘S OWNERSHIP (75%):
$400,000 (from down payment)
$800,000 (mortgage balance)

PARENT’S OWNERSHIP (25%)
The $400,000 contribution by the parents

The $400,000 contribution by the parents at the time the home is purchased is not a gift to the child and therefore it is not taxable to either party.

Phase Three: Discounted Gifting

The child is now living in and enjoying their new home. The parents own a minority interest (25%) in the home, presenting an additional gifting opportunity. The parents have a minority interest in an illiquid real estate asset. They can have a “discount” appraisal done to determine how much of a discount can be applied to this minority interest, which is both illiquid and significantly below 50%. The discount is substantial, normally ranging from 30% to 45% of pro rata market value. In our example, the $400,000 (25%) in the parents’ market value, could be discounted by 40% to $240,000. The discounted value is important as it enables the parents to pass more actual value to their child with a discounted impact on gifting.

In this example, the parents decide to make a significant one-time gift to their child, utilizing the lifetime exclusion ($11.58 million in 2020 per person) to gift their minority interest of the home to the child. After receiving the discounted appraisal, the parents file to gift their 25% interest in the home, which represents $400,000 in home market value. In the year of the transfer, the parents file a gift tax return indicating a gift value of $240,000. With the gift tax return, completed by their tax preparer along with their annual tax return, they have utilized part of their lifetime exclusion, avoiding any taxable implications for themselves or their child.

Cost considerations:
This phased approach accomplishes the goal of home ownership for the next generation. The process effectively avoids most estate taxes by functioning within the constraints of annual and lifetime gift exclusions. The process does incur some costs, in addition to the normal costs associated with the purchase of a home. These include, but are not limited to:

PHASE ONE:
• Legal fees to establish an irrevocable trust
• Annual tax preparation fees for the irrevocable trust
• Annual trustee tees (a family member is often used, reducing this cost)

PHASE TWO:
• Legal fees to establish tenant in common (“TIC”) agreement

PHASE THREE:
• Cost of discounted appraisal
• Tax services associated with filing of gift tax return

The purchase of a home is a costly endeavor. Commissions paid to real estate professionals, along with title insurance and fees, are significant. Maintenance costs and property taxes should also be considered in determining affordability for a buyer. For buyers who have achieved some stability in their lives, the opportunity to purchase a home can be both emotionally and financially rewarding. Affluent parents can help enable their children realize the goal of home ownership with minimal tax impact.

The opinions expressed in this post are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. It is only intended to provide education about the financial industry. Individual investment positions discussed should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. Please remember that investing involves risk of loss of principal and capital. Nelson Capital Management, LLC is a registered investment adviser with the U.S. Securities and Exchange Commission. No advice may be rendered by Nelson Capital Management, LLC unless a client service agreement is in place. Likes and dislikes are not considered an endorsement for our firm.