Mountain Law: When mom and dad are the bank (column)
With the high cost of housing in the mountains, it is not uncommon for parents to want to lend money to their children to purchase a home. Unfortunately, Colorado law does not make this easy, as explained in this article.
In the wake of the financial crisis, private financing has become increasingly regulated. I wrote about some of the issues in my December 2013 article titled “Real estate brokers and sellers take note: Seller financing just got harder.” The gist of that article was that seller financing generally requires structuring the loan to fall within certain exclusions under federal and state law in the face of strict penalties for noncompliance.
As tricky as seller financing has become, it is at least possible to do with careful study of the regulations. The problem for parents who wish to lend to their children, however, is that they don’t even fall within the seller-financing exclusions for the simple fact that they are not “sellers” of the real estate at issue. Unfortunately, there is currently no special exclusion at the state level that would allow parents to directly lend to their children in a secured transaction for the purchase of a primary residence without being licensed mortgage brokers.
So, what can families do? It is worth exploring options for the parents to purchase the property outright and lease it to the child, gift the money to the child or lend the money without security. Each of these approaches has practical, financial and tax implications for both the parents and the child.
From a pure financing approach, the legal consensus seems to be that parent financing cannot be done in Colorado unless the parents first purchase the property and then re-sell it to the child in compliance with state and federal seller-financing regulations. It is worth noting that this could potentially result in the family paying transfer tax twice (once when the parents acquire the property and once when they sell it to the child) in towns, like Breckenridge, that have a transfer tax. In cases where children initially place the property under contract in anticipation of parent financing, they should ensure that the contract will be assignable to the parents.
Many parents who purchase property for re-sale to a child will seek to take advantage of the “one property” exclusion for seller-financers under federal law. This exclusion generally applies in this circumstance when the following requirements are met: (1) the sellers are the parents themselves; (2) the parents only do one seller financing transaction per year (Sorry, sis’); (3) the parents did not build the home; (4) the loan does not result in negative amortization; and (4) the loan has a fixed rate or an adjustable rate that is adjustable after five or more years, subject to reasonable annual and lifetime interest rate increases and based on an index such as LIBOR. Even when the one property exclusion applies, it is still necessary to comply with requirements under state law to disclose certain loan details.
The foregoing discussion assumes that the parents are in a position to pay cash for the property outright and then sell it to the child. There does not appear to be a legal way under current state law for parents to loan their children only a down payment in a secured transaction.
In sum, parents who wish to lend to their children for the purchase of a primary home in a secured transaction in Colorado must first purchase the home and then re-sell it to the child in compliance with state and federal law. Such transactions should only be contemplated with the assistance of knowledgeable tax and legal advisors.
Noah Klug is the owner of The Klug Law Firm, LLC, in Summit County, Colorado. He may be reached at 970-468-4953 or firstname.lastname@example.org.
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