My Son’s in Default on Our Intrafamily Home Loan; Must I Foreclose?

Alternatives to foreclosing on a family member who can't pay the intrafamily mortgage.

Question

I loaned my son over $300,000 with which to buy a home. He recently lost his job, and couldn’t make last month’s payment. We’re past the grace period. I know it’s not his fault—he’s sending out resumes, and will hopefully find a new job soon—and I really don’t want to foreclose. Then again, I want to get our agreement back on track (we signed a formal promissory note), and keep my own finances clear. (If I just let this go without acting, won’t the IRS think I’m making gifts to him?)

Do I have any good options here? Will this require scrapping the old promissory note and signing a whole new one?

Answer

You’re wise to try to handle this in a structured way, for the sake of your tax and other financial concerns and your son’s. And yes, you’re right that at some point, forgiven payments are going to look to the IRS like you’re making gifts to your son, and you’d need to file a gift tax return if your total gifts exceeded that year’s exclusion ($14,000 in 2015).

Fortunately, you do have some options for dealing with your son’s nonpayment, likely even without having to prepare a new promissory note, as follows:

  • You could, as discussed just above, go ahead and forgive the missed payment completely, in other words, make a gift of the amount of the payment. (Filing a gift tax return if the total exceeds the exclusion is a hassle for you, but it doesn’t mean you’ll actually owe the IRS money.)

  • You could agree that your son will double up the payment in a later month.

  • You could postpone your entire payment schedule for an agreed-upon period, until your son is able to stabilize his financial situation and get back on track with the payment schedule.

  • You could have your son add the payment to the end of the loan term.

No matter which of these options you choose, it’s a good idea to commit your agreement to writing. It's also worth charging interest, if it’s allowed under your contract (1%, for example), to show the IRS that there are consequence for default and therefore it isn’t a gift. (You could, however, potentially gift the amount of the penalty to your son and have him turn around and pay it to you; talk to a tax adviser for a full analysis.)

If none of those options look attractive, you could completely restructure the payment schedule, for example turning it from an amortized loan to interest-only. For this, however, you’ll need to write up a new promissory note.

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