Expert Advice When You Need It Most

Borrowing money from family members, guidelines for setting up loan agreement under WA state law

Asked over 3 years ago - Seattle, WA

I am trying to determine the best way legally for both sides to borrow money for a home remodel project from a family member.

Basically, I plan to fund a roughly $150k home remodel with money borrowed directly from my brother. What legal issues should I be aware of to ensure a safe scenario. I would plan on borrowing this money with a 5-10 year payback plan at a reasonable interest rate (similar to a traditional home mortgage).

Some questions that come to mind:

1. How can money be legally transferred since this amount is much higher than the legal gift limit?
2. Can my brother secure his investment in the case of my death, etc.?
3. What are the tax liabilities for the loaner (my brother) on interest earned on this loan? I imagine similar to any other investment?
4. What tax write off options do I have? I assume similar to any other traditional loan through a bank?
5. Are their any complications with my current bank mortgage on the house I need to be aware of?
6. Do I need an attorney to secure all of the documents/transactions for a scenario like this? If so, which type of attorney?

One other variable in this scenario worth noting is that I do not plan to pay back the loan + interest on a monthly payment schedule like a traditional mortgage loan, but rather as one lump with all built up interest. Does this present any significance to the scenario?

Looking for any and all advice on this type of situation. Thank you in advance!

Flag

Save

Share with:

Attorney answers (1)

Bruce Givner

Reputation Level 12

Answered over 3 years ago. Tax Lawyer in Los Angeles, CA.

Flag

First, your brother can loan you $150,000 if he wishes to do so. A loan is not a gift. So it is not subject to a "legal gift limit." Presumably by "legal gift limit" you either mean the (i) $12,000 annual (per donee) gift exclusion or (ii) the $1,000,000 (per donor) lifetime transfer tax exclusion. Or, perhaps you mean the $100,000 limit on no interest loans. That is discussed in more detail below.

Second, of course your brother can secure his loan. He could, for example, require you to apply for an own a life insurance policy on your life in the amount of at least $150,000 and name him as the beneficiary.

Third, the interest paid to your brother would be ordinary (investment) income. It is not in the same "basket" as wage income. However, that is something for him to discuss with his CPA.

Fourth, if the loan is secured by your principal residence and if it is for "substantially improving, then you may qualify for the home interest deduction. Go to Findlaw.com and look up Internal Revenue Code Section 163(h)(3)(B) and (C).

Fifth, if your brother wants a deed of trust on your residence to secure his debt, then it may very well cause problems with the bank that holds the first trust deed. You need to read the first trust deed to be certain.

Sixth, it would be best to hire a real estate lawyer.

Finally, if you do not pay the interest on a current basis that will create a cash flow problem for your brother, since he will be required to pay tax on the interest on a current basis even if he does not receive it. That is because the loan is larger than the $100,000 gift loan limit. See Internal Revenue Code Section 7872(d)(1).

Mark as good answer

12 people marked this answer as good

Add comment