An issue came up that we've touched on, but I don't recall the specifics and would appreciate your input.
When someone makes a loan but forgives one or more payments, the loan is required to include interest. If the interest goes unpaid as well, it seems to me that there are a couple of ways (at least) this could could be treated:
1 - the recipient has cancellation of debt income for the interest, or
- The donor has income for interest he was entitled to but forewent.
How does the IRS treat this in practice? Do the parties have a choice, or is there one way they require the transaction to proceed?
In this case parents want to lend children money for the downpayment of a house, payable over nine or ten years (in part but not completely to keep the gift under the gift tax exemption). They will probably forgive the payments as they come due, though they reserve the right not to do so.
If they sign the bank's "gift letter" saying the money was a gift even though it was really documented as a loan (I know, I know, bank fraud, but I'm looking at the tax implications) is that something the IRS would look at to determine if the gift was all made all at once?
Final question - the parents are considering buying the property with the kids, taking title 35%/65% (the down payment will be 35%). Then they would make gifts of proportional interest in the house each year until the kids own it outright. It seems to me that this would avoid the imputed interest issue. Am I missing something? Are there other considerations?
Thanks a lot for your thoughts.
Stu