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The father would like to find the best way to help his (~40 year old) daughter with approximately $200k in home loans.

Without (yet) seeking professional advice, he has loosely considered:

  1. Gifting her the money.
  2. Loaning her the money at 2% interest, and allowing her to pay him conventionally, perhaps forgiving the loan at some later point in time (or upon his death).
  3. Buying the home and place it in trust for the daughter and her children.

The daughter is unmarried and has two children, one 6 years old and the other 22 years old.

From a U.S. federal tax liability point of view (for everyone concerned), what would be the best option here? What concerns would be involved?

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Firstly, there is also a lifetime gift+estate tax allowance. If the father's estate, including other gifts given in his lifetime, is unlikely to exceed that allowance, it might be simplest simply to give the whole amount now and count it against the allowance.

Right now the allowance is $5.34M, but that seems quite a big political football and it's the allowance when you die that matters. Looking back at past values for the allowance, $1M seems like a pretty safe amount to bet on.

If you want to avoid/minimize the use of that allowance, I would make a loan structured as a mortgage that will have $14K payments each year (which can then be forgiven). The points in Rick Goldstein's answer about an appropriate rate, and being able to give more if more notional donors and recipients can be used, also apply.

So for example in the first year hand over $200K at 3.5% and immediately forgive $14K. The next year, forgive the interest charge of $6.5K and capital of $7.5K. Given the age of the daughter, I guess the father might well die before its all paid off that way, leaving some residue to be forgiven by the estate (and thus potentially incurring estate taxes).

There might also be state gift/estate taxes to consider.

Edited to reflect 2014 gift and lifetime exclusion limits.

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    +1 - Ganesh - you nailed it in the first paragraph. Father files a gift tax form and declares the gift, no tax, no ongoing paperwork. Einstein was quoted as saying "Things should be made as simple as possible, but not any simpler. This first suggestion does just that.
    – JTP - Apologise to Monica ♦
    Jan 7, 2012 at 3:00
  • @JoeTaxpayer - is it worth keeping this up to date every year? I'd be inclined to make it clear that it refers to the 2012 figures but expounds general principles.
    – GS - Apologise to Monica ♦
    Nov 26, 2013 at 8:50
  • There are a few questions referencing numbers that change each year. My edit now this answer up to 2014. I think there's value to keeping these current, and will do so when I stumble across them or have them brought to my attention.
    – JTP - Apologise to Monica ♦
    Nov 26, 2013 at 13:05
  • My concern is that the connection to the question will become increasingly remote over time, particularly if there's a step change. I'm not suggesting you do this, but if you update the threshold numbers, why not also update the question for inflation?
    – GS - Apologise to Monica ♦
    Nov 26, 2013 at 14:26
  • Sorry, I don't understand the suggestion. Do you mean correcting the 2% to be close to the IRS' mandated rate, or something else? The rest of the question looks pretty generic to me.
    – JTP - Apologise to Monica ♦
    Nov 26, 2013 at 14:42
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Gift taxes kick in at around $13K per giver per recipient per year. That means that a straight up gift of $200K (as cash or a house) will incur a tax. It is possible, however, that if the father has a spouse, he and the spouse could each give the mother and each child the full gift limit, for a total of about $78K per year, and that money could be used by all 3 of them to buy the house jointly, over a couple of years. I think the children would have to be on the title, since part of the gift money would be theirs (and one is an adult).

As far as lending the money, my in-laws are our mortgage lenders, and when we structured the loan, it had to be at a market rate (which could be the lowest advertised rate we found for a fixed-rate mortgage, independent of what we might actually qualify for) or we could not deduct interest payments. Forgiving the loan could also be considered a gift, so they would need to keep an audit trail showing that payments were made, and her father would need to declare the interest income on his taxes.

If he bought the house as a second home and let her and her children live there rent-free, it might work, but I'm not sure. It would, in that case, be an asset of his estate when he dies. I don't know anything about structuring it as a trust. Free rent could conceivably also be construed as a gift, subject to the limits stated above.

Disclaimer: Not a tax professional.

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    You don't want to add a child to the title. It will be very had to remove them later. They would have to be represented by an advocate to protect their interest. That would take time and money.
    – mhoran_psprep
    Jan 6, 2012 at 22:58
  • @mhoran_psprep - Excellent point. It would be costly and complicated, but necessary if you wanted to use the child's gift money to buy the house. Probably not a good choice.
    – Rick Goldstein
    Jan 6, 2012 at 23:17
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    Yes $13K/yr is correct. But see my comment on answer above. One gift, one form, no ongoing stuff. Forgive my quirk, ongoing stuff makes me nuts. (The gift does not incur tax but requires paper, once. )
    – JTP - Apologise to Monica ♦
    Jan 7, 2012 at 3:02
  • Why not simply have each child gift half of his $26k gift to the mother, so the mother would receive a total of $52K a year under her name?
    – Pacerier
    May 14, 2013 at 15:00

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