If your parents offer to help you buy your dream home by giving you money for the down payment, chances are they don't want to get slapped with a stiff tax penalty for their generosity. By staying within the bounds for tax-free gifts as stipulated by the Internal Revenue Service, you can enjoy your new home and your parents can save some cash to boot.
Gift vs. Loan
As consumer mortgage website Mortgage Loan notes, it's imperative to discuss openly with your parents whether the down payment is meant as a gift, loan or even an advance disbursement of an inheritance. Clarifying these issues -- in writing -- can prevent potential confusion or strife in the future. On a practical level, the gift or loan status can impact future tax consequences. If the money is a loan, your parents will need to enforce repayment or potentially be on the hook for gift taxes.
If your parents give you the down payment as a loan, they must charge the current applicable federal rate for long-term loans in effect during the month and year the loan is finalized. This will help prevent the government from interpreting the loan as a gift, and any uncharged interest as taxable income. You'll have to provide formal documentation of any loan money given by your parents as part of the mortgage underwriting process. Your formal loan statement should contain the interest rate, term, transferability of the loan and an amortization table showing how much needs to be repaid and how much equity will grow during the loan's lifetime.
Gift and Estate Taxes
As of January 2015, your parents can gift you up to a maximum of $28,000 a year as a couple, or $14,000 each as individuals, for a tax-free down payment. If you are married, your parents can also gift the same amount to your spouse, making it possible to put down a $56,000 down payment as a tax-free gift. If this amount is not enough for your down payment, your parents can give more money, but they'll have to report it on tax form 709. Any excess can be included in their lifetime estate tax exemption of up to $5.43 million as of 2015.
Other Tax Implications
While Americans can avoid gift taxes by staying within gifting limits, loans might require additional footwork to offset other taxes. As personal finance website Interest.com notes, both parent and child need to take extra steps for a child to receive additional tax benefits, such as deductions on mortgage interest. The child should use form 1098 to report the amount of interest paid on a parental loan and the parent should declare the interest earned on form 1099. These two figures should match.