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Law Offices of Ronald W. Rutz
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February 14, 2004: Giving Children Their Inheritance Early?

Q: I want to help one of my children buy a new house. So I am going to give each of my two children an equal amount. They can have their inheritance early. I would much rather help now when they need it than make them wait until I die.

A: I know that you have two goals, each of which seems to be in conflict with the other - helping one child buy a house while still treating each child equally.

If you just give an equal amount to each child, your only remaining asset of any value would be your house and your only income would be from social security. You would lose your financial independence and a significant part of your income (earnings off the money given away). And even though you are certain that both of your children would step forward to provide a financial safety net for you (I hope you would be correct), one or both may not, or there might be a divorce or financial difficulty for a child which would prevent him or her from doing so. Even worse, one might die with an unsympathetic daughter-in-law or grandchild involved.

The following is a suggestion to consider: instead of gifting to both children, make a loan to the child buying the house. That way, the other child is not being discriminated against because your overall assets are still the same (exchange financial assets for a note), yet you are helping a child while you are alive.

The loan should be written as a promissory note with installment payments and secured by a deed of trust (mortgage) just as the bank would do. If the deed of trust is a second mortgage (there is another loan in front of it), then be sure that all of the secured loans, including this one ahead of you, are less than 80% of the value of the house. That way if you have to foreclose to get your money back, there would be a cushion to cover the actual sales price and foreclosure costs.

The note can provide for a rate of interest that might be higher than you can otherwise get investing and if you want to gift to the children, forgive (as a gift) part of the installment payments and gift an equal amount to the other child to treat both the same. The installments to you would be taxable to the extent that part of it represents an interest payment (like any payment), so keep back enough of the installment money to at least pay the taxes if you are "gifting" the rest through forgiving part or all or the payments. DonŐt charge a low interest rate because you need to be fair to the other child. Plus, the interest is deductible by the child paying and you can forgive part or all of it anyway.

Then if we lose you, the child on the note can receive it as part of his or her inheritance and the other child would receive the other assets. The note back to the child in effect wipes out the debt so it is like increasing that childŐs net worth. If the note is more than half of the estate assets, then the other child would receive part of the note. But the child who is liable on the note can continue to pay that part or cash out the other sibling.

Out of space but not out of points! I have had so many inquiries along this line that I just wanted to pass this along as a suggestion. The asset in question doesnŐt need to be a house, but can be any investment such as a stock, collectibles, precious metal, etc. Just set up an actual note and take back security to protect yourself and be fair to the other child in case of problems.

However, any loan to a child should be represented by a signed note, whether secured or not. This establishes the amount owed; that the money advanced is a loan, not a gift; and that the current balance can be determined if payments are noted on the document.

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