Empowering Next-Generation Wealth: Top 4 Tools UHNW Families Use for Their Children's First Home Purchase

In today's climate, Empowering Next-Generation wealth in purchasing a house has become more of a collaborative effort within Ultra-high Net Worth (UHNW) families. Due to rising interest rates, high demand from young buyers, and a scarcity of available housing, parents have increasingly become involved in their children's home-buying process. If you wish to financially assist your children or grandchildren in buying their own home, what are your options?

To help you decide, we describe some of the key issues you might want to explore, as well as the four main tools parents commonly use to help children into new homes: outright gifts, loans, leases, and irrevocable trusts.

2024 Real Estate Market Conditions

Unsurprisingly, more clients have been asking us recently how best to help their children buy their first homes. Housing prices, mortgage rates, and competition for homes are all high.

Home prices rose an incredible 37.7% for the four years 2020 to 2023.

While prices may have come down a bit depending on the metro area, they have not dropped significantly in most areas of the country—nor do we expect them to for two reasons.

First, demand remains strong. Millennials (aged 27–44) now form the largest generation group in the United States (about 72 million strong), and make up the largest percentage of new home buyers (43%, according to the National Association of Realtors). They are projected to be the dominant force in the home market for years to come.

Second, supply remains limited. Since the 2008 bursting of the housing bubble, new home development in the United States has lagged demand. We estimate that today this gap totals approximately 2 million–2.5 million too few housing units.

Counterintuitively, the recent surge in mortgage rates is worsening the housing shortage. Homeowners who refinanced during the period of lower rates in 2020 (setting a record for the highest number of refinances) and in 2021 (the third highest, trailing only 2003) are now disincentivized to move and commit to a new mortgage with the current higher rates.

Meanwhile, our clients' children, accustomed to certain lifestyles and desiring quality school districts for their own children, often seek homes in more expensive areas.

Do you want to help and if so, how much?

Before you decide to assist your children in buying a home, it is essential to carefully evaluate the potential impact it may have on your personal wealth goals. You need to consider several factors, such as whether you want to help with the down payment or the purchase price, who will take care of the carrying costs and future improvements, and if you have the capacity and willingness to do the same for each of your children. You must also decide whether to treat them equally or

provide a bonus if they choose to live close to you. Additionally, you must determine if you want to structure it as a pool of funds to be used for any of a handful of reasons as they see fit. You can include your answers to these questions in your personal wealth plan to ensure it doesn't put any other goals in jeopardy.

Moreover, it is crucial to consider all potential family issues that could arise from your offer of help. You need to adopt a family policy about gifting and communicate that policy to them. Some options include saying, "This is your inheritance early," setting a certain dollar amount as a gift that will be extended to all children, no matter what they use the funds for, or adding a "bonus" if your children choose to locate within a certain distance of the family home. Whatever the policy, there remains the issue of how you would assist your child exactly.

Option 1: Gifts

Perhaps the simplest option is to provide cash that a child can use as a down payment on a home, or to buy one debt-free. Such a gift would almost surely require that you file a U.S. gift tax return. However, you wouldn’t have to pay U.S. gift taxes unless the gift pushed the total amount of taxable gifts you have made during your lifetime over your lifetime gift tax exclusion ($13.61 million per person in 2024 but be careful this resets to $3.5M on January 1st, 2026 and you may have a state-level gift tax if you live in Connecticut).

If you give only enough for a down payment, your child will presumably apply for a mortgage for the balance of the purchase price. If your child’s income and/or assets will not alone be sufficient to qualify for a mortgage, you could act as a co-borrower or (under certain circumstances) as a guarantor.

This gifting strategy assumes your child will take title to the home, either solely in her individual name or jointly with their spouse. This means the home might be subject to potential creditors—which includes her spouse if there’s a divorce. (You might save her from losing her home to an ex-spouse by putting your gift into a well-drafted and well-managed trust for her benefit rather than giving her the money outright.)

Option 2: Loans

If you're planning to help your child purchase a home, one option is to lend them money up to the full purchase price and have the title taken in their name. To protect against potential creditor claims, the loan could be made to a trust for the child's benefit, which would hold the title. However, the loan must be supported by a note so that no part of the loan is regarded as a gift by the Internal Revenue Service.

To ensure that the loan is not treated as a gift, it must carry a minimum interest rate known as the Applicable Federal Rate (AFR). This rate is usually lower than commercial mortgage rates. The interest earned on the loan is taxable income to you, and if it is secured by a mortgage, your child can claim interest on the first $750,000 of the debt as deductible mortgage interest.

Parents can choose to forgive the interest or even the principal instead of collecting interest. Typically, parents tend to forgive up to the annual gift tax exclusion amount, which is $18,000 per parent in 2024 or $36,000 per couple. Even if the interest is forgiven, it is still considered income to the parents, and they must pay taxes on that amount at ordinary rates.

Parents usually use their own money for the gift or intra-family loan to help their child buy a home. However, another option is to pledge assets, such as marketable securities, as part of the loan collateral for your child's home purchase. This pledge is often used instead of a down payment and offers the benefit of allowing the assets to stay invested and continue to grow over time, as well as potentially avoiding any gifting implications.

Option 3: Leases

If you have a child who lives in a home that you own, you can avoid any gift tax consequences by leasing the space to your child at a rent that reflects the fair market value. You can determine the fair market value by consulting with a realtor. Keep in mind that the rental income will be subject to income tax. However, if the home is considered business property in your hands, ordinary and necessary carrying costs, such as taxes and maintenance, may be deductible. Since you still own the house, it will be included in your estate or your spouse's estate. Therefore, it's important to consider the property in your overall estate plans.

Option 4: Trusts

If you're looking for a way to provide financial assistance for your child to purchase a home, using an irrevocable trust can be a good option. However, setting up an irrevocable trust can be difficult and expensive. If you already have an irrevocable trust set up for your child, you may be able to use it to buy a home. There are two options available in this case:

1. The irrevocable trust can buy the property. The trust can either purchase the home for cash or make a down payment and finance the remaining balance with a commercial mortgage. In either case, the trust will own the property and will be responsible for all expenses related to the property's ownership, such as property taxes, homeowners' insurance, and common charges. Your child will have the right to live in the home rent-free as a beneficiary of the trust, but their spouse will not have any ownership interest in the property.

2. The irrevocable trust can make a distribution to your child and their spouse, allowing them to purchase and jointly own the home. However, the laws of the state in which the property is located will determine how this "marital property" is treated. Generally, a trust distribution to a married beneficiary is considered their separate property. If the beneficiary uses the distribution to buy a home that is titled jointly in both spouses' names, the beneficiary has effectively made a gift to their spouse.

Sourcing your capital

Every person and family has a unique situation. However, if your child is a Next Gen buyer, an adjustable-rate mortgage (ARM) might be a better option than a fixed-rate mortgage for a couple of reasons.

First, interest rates are likely to decrease in the next few years, so if they choose an ARM, they can pay a lower rate now than they would with a fixed-rate mortgage. Then, they can refinance to a lower rate later, possibly into a fixed product.

Secondly, most people in their twenties and thirties are not buying their permanent homes, and they are likely to sell in the next five to ten years. On average, people in this age group have a mortgage for seven years.

Summary

Navigating the current real estate landscape, marked by high prices, competitive markets, and limited supply, requires thoughtful consideration for parents looking to assist their children in purchasing homes. We outline four powerful tools commonly used for this purpose: outright gifts, loans, leases, and irrevocable trusts. The importance of evaluating personal wealth goals, considering family dynamics, and adopting a clear gifting policy cannot be overstated. Each option comes with its own set of implications, including tax considerations and potential impacts on personal wealth underscoring the need for a strategic approach, and aligning financial assistance with individual circumstances and preferences.

Footnotes

1. Source: U.S. House Price Index Report - 2023Q2 | Federal Housing Finance Agency (fhfa.gov)

2. Source: National Association of Realtors. https://www.nar.realtor/newsroom/nar-report-shows-share-of-millennial-home-buyers-continues-to-rise. Accessed Jan 28th, 2024.

3. Source: Haver Analytics. Data as of September 30, 2023.

4. Freddie Mac.

5. Among states, only Connecticut has a gift tax; its exemption amount ($13.61 in 2024) is matched to the federal amount and the top marginal rate is 12%. This material is distributed with the understanding that it is not rendering accounting, legal or tax advice. Consult your legal or tax advisor concerning such matters.

6. This can be a topic of debate among tax and legal advisors as to whether this constitutes a gift. Check with your tax and legal advisors before taking action.

7. Internal Revenue Code Section 61(A)(5).

8. For additional information, see IRS Publication 527, Residential Rental Property at https://www.irs.gov/publications/p527. This material is distributed with the understanding that it is not rendering accounting, legal or tax advice. Consult your legal or tax advisor concerning such matters.