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I recently got an email from a close friend of mine, that goes something like this:

We're looking to sell our rental house and buy a new one. We found one we like, but the housing market is very hot right now and it's not likely to be on the market for long. Unfortunately, the last tenants kind of trashed the old place, and we won't be able to sell it until completing some repairs that will take a while.

We'd like to make a contingency offer on the new house, where the purchase is contingent on the sale of the old one going through, but to make it work we'd need to be able to put down a bigger down payment than we can afford at the moment. If you can kick in $$$$ to help us with the down payment, we would be able to return it, plus 15%, when the sale of our house closes. It would have to be made as a "gift", and then the return would be a "gift" back to you, because you're not allowed to use a loan for a down payment.

First and foremost, before anyone says anything, there is a 0% chance that this is a scam or an attempt to bilk me out of money. I know these people well enough, and know enough about their home life, to know that they're trying to do exactly what they say they're trying to do and the offer is in earnest.

The part that has me worried is the last bit. If I go through with it, is it going to look like some sort of scheme to evade taxes or skirt regulations and end up with me and/or my friends getting in trouble with the law?

(All proposed transactions are taking place in the USA. Not sure if this or Law.SE would be a better place to post the question.)

EDIT: A few answers so far have focused on potential mortgage problems. Just to clarify, the plan is to sell house #1 and "roll it over", using the money to buy house #2. As far as I know there won't actually be a mortgage involved.

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    This doesn't make sense. If the sale of the old house will provide enough to cover the loan + 15%, then it would also be enough to cover the needed down payment amount. They don't need the down payment until closing, and with the contingency means it's after the other house is sold. They only need some earnest money to make the contingency offer, which can be much smaller than the down payment. So, why exactly do they need money right now? – TTT Jun 22 '16 at 15:41
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    OK, but earnest money could be as little as $1000, maybe more depending on the purchase price. Do they really not have even that much on their own? How much are they asking for? – TTT Jun 22 '16 at 15:48
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    Are they willing to put this down on paper in legal terms ? Or put up some type of collateral which is legal and can be enforced in court ? – DumbCoder Jun 22 '16 at 16:08
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    I don't understand why he would want the money as a gift if there is no mortgage involved. The only reason to do so is because lenders won't allow loans to be used for down payment. If it's for a deposit, the buyers won't care where the money came from (and it would be unusual for them to ask for the source). – TainToTain Jun 22 '16 at 18:13
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    It sounds like, at the least, you would need to sit down with your friends and get a much more complete explanation of exactly what their plan is. – BrenBarn Jun 22 '16 at 18:57
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It would have to be made as a "gift", and then the return would be a "gift" back to you, because you're not allowed to use a loan for a down payment.

This is not to evade taxes. This is to evade a credit check. The problem is that banks don't like people to have too much debt. The bank could void the loan and go after your friends for damages under certain circumstances, as this is a fraud on the bank. Perhaps you might be guilty of conspiracy to commit fraud or similar.

I'm willing to assume for the sake of argument that there is zero chance of your friend not paying you back intentionally. But even so, there are still potential problems. What if your friends end up without the money to pay? Worse, what if something happens to them? This is an off-books transaction. You couldn't make a claim against the estate, as there can't be a paper trail. You'd be left out the money in those circumstances.

You'd both be safer if your friends saved up for the next opportunity rather than trying to grab this one.

An alternative would be to buy a share of their current rental house. That would give them the necessary money and would give you paper showing your money. It's not a gift, it's a purchase. You'd have to pay capital gains tax on the 15% profit that they're promising you. But you'd both be above board and honest.

  • Let us continue this discussion in chat. – TTT Jun 22 '16 at 19:47
  • @Grade'Eh'Bacon What if your friend says, "Lend me $1,000 and I'll pay you back $1150 as a thank you" and you reply "Here, borrow this $1,000 and you can just repay this amount, we are friends and the extra $150 isn't necessary." but then the friend pays you the $1000 and gives you $150 extra as a thank you? – Michael Jun 22 '16 at 20:50
  • @Michael - (I am not a tax professional so I may be wrong, but) if you had no reasonable expectation of receiving the $150, then I personally see that scenario as a gift. (I used to see the previous scenario as a gift too, but JoeT and Bacon whipped me into shape on that one.) – TTT Jun 22 '16 at 22:47
  • Note - when a mod invites the comments to move to chat, the existing comments are moved as well. When a member does so, they remain. I've deleted them, in favor of the chat created by @TTT. (Please do not add any further comments here) – JoeTaxpayer Jun 23 '16 at 12:55
  • @Michael - I spent a shockingly long time last night thinking about your proposed scenario and my response to it, and I now think it may not be a gift, even if you didn't expect it. It prompted me to ask a related question: money.stackexchange.com/questions/66495/is-it-a-gift-or-not (JoeT - please feel free to move these additional comments into the chat.) – TTT Jun 23 '16 at 17:43
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Your Spidey senses are good. A good friend would not put you in such a position. It's simple, to skirt some issue (we'll get to that in a second) you are being asked to lie. All for a 15% return on your $$$$. <<< How much is that?

You can easily lend him the money, and have a better paper trail. But the bank is not going to like that, and requires this money from friends or family to be a gift. I've heard mortgage guys at the bank say "It's just a formality, we need this paperwork to sell the loan to the investors." These bankers belong in jail, or at least fired and barred from the industry. They broke the economy in 2008, and should be stopped from doing it again.

6

If you can separate the following two points, and live with them. I think you are good to go ahead. Otherwise I would seriously recommend you to reconsider.

  1. Your friend just asked you to give you money so they could buy their dreamhouse.

Are you willing to give out this much money help a friend assuming that you will never get it back? This is what it means to give a gift, don't let their current intentions distract you from this.

  1. Your friend intends to give you some money someday

Will you be happy to wait as long as it takes till he is able and willing to give you some money? Is it ok if this moment never occurs, or would you feel like the money belongs to you already? This is what it means to receive the promise of a gift, don't get distracted by the fact that you may have given them something before.


I don't have a legal background, but if you actually give the money to him so he can buy a house, without demanding something in return, I would judge that you are at least morally ok. (And if the transaction is in cash and fully deniable, you are probably not going to face legal problems in practice).

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Adding to what others have said, if the mortgage for the new house is backed by the federal government (e.g., through FHA or is to be sold to Fannie Mae/Freddie Mac) you would be violating 18 USC § 1001, which makes making intentionally false statements to any agent or branch of the federal government a crime punishable by up to 5 years' imprisonment. The gift letter you are required to sign will warn you of as much.

Don't do it, it's not worth the risk of prison time.

  • I'm pretty sure that there won't actually be a mortgage involved; the plan is to sell house 1 and use the money to buy house 2 outright. – Mason Wheeler Jun 22 '16 at 18:01
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    Perhaps you should edit your question to reflect that. The term "down payment" usually refers to a mortgage. It makes no sense that he would need the money as a gift if there is no mortgage involved. – TainToTain Jun 22 '16 at 18:04
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    @MasonWheeler I agree with TainToTain; if there was going to be no mortgage, and you would therefore be the only lender in the transaction, you could do it as a documented loan, not as "back to back coincidental and definitely not fraud" gifts. – Grade 'Eh' Bacon Jun 22 '16 at 18:39
  • @Grade'Eh'Bacon Maybe so, but the "down payment" part of Mason's question is in a quote block... which presumably means that it came from his friends and that he should make absolutely sure of the circumstances before following advice from people on the internet. – Michael Jun 22 '16 at 21:15
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    @supercat The gift letter that lenders want for FHA/FNMA mortgages specifically require the giver to state that there is no obligation, express or implied, to repay the money at any time. They won't accept just, "I hereby waive any legal authority to reclaim the money." – TainToTain Jun 23 '16 at 17:07
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As an investment opportunity:
NO.

As a friendly assist with money you don't mind ever getting back, legal depending on amount.

A few years back I was in the housing market myself and researching interest rates and mortgages. For one property I was very interested in, I would need about $4K extra in liquid cash to complete the down-payment. A pair of options I saw were a "combo loan" 15yr 4% interest for the house, 1yr 8% interest for the $4K. Alternately, the "bank of mom and dad" could offer the 4K loan for a much lower rate.

The giftable limit where reporting is not required was $12,000 at the time I did the review. IRS requires personal loans to be counted as having interest at the commercial rate. Thus an interest free loan of $10K with commercial interest rate of 1% (for easy math) would be counted as a gift of $10,100 for that calendar year.

Disclaimer: Ultimately, I did not use this approach and did not have it subjected to a legal review.

  • And no intent to defraud or evade credit was involved. All requisite credit checks were completed in advance (pre-approval process.) – user1361991 Jun 23 '16 at 17:13
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Every time I have loaned money to family members I have never gotten the money back.

If they can't make the down payment, they should not be taking out the loan.

It's a bad idea to loan money to friends, because when they can't pay you back (which might be forever) they avoid you. So, you lose both your money and your friends.

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If they own the old house outright, they can mortgage it to you. In many jurisdictions this relieves you of the obligation to chase for payment, and of any worry that you won't get paid, because a transfer of ownership to the new owner cannot be registered until any charge against a property (ie. a mortgage) has been discharged.

The cost of to your friends of setting up the mortgage will be less than the opulent interest they are offering you, and you will both have peace of mind. Even if the sale of the old house falls through, you will still be its mortgagee and still assured of repayment on any future sale (or even inheritance).

Complications arise if the first property is mortgaged. Although second mortgages are possible (and rank behind first mortgages in priority of repayment) the first mortgagee generally has a veto on the creation of second mortgages.

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it seems you have 3 concerns:

  1. taxes. this shouldn't be a big deal, but might require some paperwork (especially if it is over 14k$). technically the irs would probably see this as a loan, not a gift, based on the step transaction doctrine. but that is not the kind of thing they would get worked up about. if you make your best guess regarding gift vs loan when filing your taxes, you won't get in any real trouble even if they disagree during an audit. see this answer for a similar example: If I repaid a monetary gift, is still considered a gift by the IRS?
  2. fraud. if you truly beleive this is a gift, and any repayment would be out of gratitude not obligation, then i don't think this is an issue. even if the irs taxes it as a loan, it is still legally a gift if that was the intent at the time you signed the loan paperwork. the emotional consequences of non-repayment are not a legal issue in a fraud case. on the other hand, if you truly think this is a loan and not a gift, then you are commiting fraud and could get caught if you ever try to seek repayment. so, if you do this, you should accept this is a gift and hope for (don't seek) repayment.
  3. non-repayment. obviously, since this is a gift as per #2 above, you have no legal recourse if they chose not to repay you. hopefully you love the borrower enough to let them keep the money if they decide that is best for them. if not, this is probably not a good "investment". counting on your friend to "do the right thing" is a poor plan. anyone who tries to borrow from friends is in a precarious enough financial situation that they could end up filing bankruptcy with a little streak of bad luck. even if they don't lose their job or become disabled, are you prepared to ask for your money back from their children after a fatal car crash?
  • The OP's 'intentions' are not all that matters. Anyone looking into this matter (either for tax or credit investigations) may choose to fight the transaction based on its appearance. And being 'right' is often of little benefit when fighting a large bureaucracy with the ability to apply penalties. – Grade 'Eh' Bacon Jul 5 '16 at 12:53
  • @Grade'Eh'Bacon i think the point is that no one will pick a fight with the OP. the irs tries to be nice because everyone already thinks they are all jerks. and the bank won't waste their time suing the OP for damages if the loan recipient defaults. the loan recipient might theoretically get into some trouble, but even that is pretty dubious as long as they don't make any payments to the OP after they start missing payments on the bank loan. besides, "intent" is absolutely critical in a fraud case. you can't even really define fraud without using the word. – james turner Jul 6 '16 at 18:52
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It would have to be made as a "gift", and then the return would be a "gift" back to you, because you're not allowed to use a loan for a down payment.

I see some problems, but different ones than you do:

  1. Because you->them is recorded as gift, you don't have any claims when they refuse to pay you back.
  2. It's not evading taxes, it's creating taxes. If you lend someone amount X and receive X back, often there is no tax involved, as the total is 0. If there is an interest, you pay the tax on the interest alone. But if you gift them, you pay gift tax on the full amount. When they pay you back, they pay gift tax on the full amount again. It's asking to tax the same money twice! (if the gift is over annual limit of $14k) As Brythan mentioned, this could be a costly way to stay under credit check radar, but the real question for you here is if 15% is enough to cover the tax.
  3. If the "gifting" is off-the-record then they may get in trouble when IRS will ask them how they got so much money without paper trail.

One more question: is the market really hot right now? It was quite cold for the last few years.

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    "But if you gift them, they pay income tax on the full amount." No. That's not even one of the issues with this. – JoeTaxpayer Jun 23 '16 at 12:17
  • @JoeTaxpayer Yeah, I forgot in USA it's the donor who pays the gift tax not the receiver. – Agent_L Jun 23 '16 at 12:39
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    Not even that. For a gift, up to $14K per giver/recipient combo (That means a couple can gift another couple $56K) no tax is due, and no paperwork is required. Over that amount, still no tax, but one files paperwork to tap their lifetime gifting amount, which is over $5M. – JoeTaxpayer Jun 23 '16 at 12:41
  • @JoeTaxpayer Well, you'll need that 5M for your children and grandchildren so I don't think it's reasonable to assume OP would want to start biting chunks of that. – Agent_L Jun 23 '16 at 12:46
  • From your facebook profile, I see you are in Poland. Your comment is right. I'd just share with you that less than 5% of US families have over $1 million, and less than 1%, $5 million. If the estate tax/gift tax is actually an issue, they probably aren't posting here. Note, the $5M combines, so a couple has $10M+ to gift/leave on their death. – JoeTaxpayer Jun 24 '16 at 15:59

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