Best way to forgive loan family mortgage?

[ME3199]

I am in North Carolina.

In 2003, my wife and I received a loan from her grandmother to help purchase our house. At the time we treated the loan normally and made monthly payments. That was the only loan we needed, and basically paid for the house in full at the time of purchase. Two years ago my wife's grandmother passed away and her daughter (my wife's mother) inherited the loan. My wife's mother would like to just give it to us or forgive it with the least tax penalty. What we have been doing is this.
She gifts us 12,000 a year, which I put down as $1000/month and calculated the interest/principle payments on a $60,000 loan. So we claim that we paid her 1000 a month for the year (money which never exchanged hands) and it comes to about 2,400 in interest and 9,600 in principle. If we do this for the next few years the loan will be paid of by 2012. (and yes we adjust the 12,000 gift amount as the gift allowed amount increases)

So here are the questions:

1) Does my mother in law need to claim the interest (or anything more) as income? (we have been assuming she does)
2) Is this the best way to do this?
3) Is even monthly payments the best way (which is how the loan notice was drawn up) or can I ration it out so that we paid more in January, and thus the interest is less for the year.

Thanks for your time.

[LdiJ]

Originally Posted by ME3199

I am in North Carolina.

In 2003, my wife and I received a loan from her grandmother to help purchase our house. At the time we treated the loan normally and made monthly payments. That was the only loan we needed, and basically paid for the house in full at the time of purchase. Two years ago my wife's grandmother passed away and her daughter (my wife's mother) inherited the loan. My wife's mother would like to just give it to us or forgive it with the least tax penalty. What we have been doing is this.
She gifts us 12,000 a year, which I put down as $1000/month and calculated the interest/principle payments on a $60,000 loan. So we claim that we paid her 1000 a month for the year (money which never exchanged hands) and it comes to about 2,400 in interest and 9,600 in principle. If we do this for the next few years the loan will be paid of by 2012. (and yes we adjust the 12,000 gift amount as the gift allowed amount increases)

So here are the questions:

1) Does my mother in law need to claim the interest (or anything more) as income? (we have been assuming she does)
2) Is this the best way to do this?
3) Is even monthly payments the best way (which is how the loan notice was drawn up) or can I ration it out so that we paid more in January, and thus the interest is less for the year.

Thanks for your time.

She is forgiving a portion of the principal, and the year's interest as a gift. No, in my opinion that would not be taxable income to her. However, someone else may have a different opinon.

[ME3199]

Thank you for your response.

[tranquility]

This can be a complex situation. Loans to relatives or other close people requre an imputed interest. That means, that even if the creditor charges nothing, the government requres a pretend amount of income on the part of the creditor.

It is difficult to advise without more facts. If the gift maximum ($1million) is not a problem, I'd say just gift the loan and file a gift tax return with no tax due. If the creditor (now mom) may want to gift a lot more in her lifetime, other things can be done. She can gift the AFR 110% each year and the amount left against principal.
This will forgive the loan over time.

This is a great situation to be in. Spend a couple of hundred dollars to see a professional and deal with this appropriately. You can make it go away with no problem, but you should be careful to make sure the government doesn't get a piece.

[ME3199]

Thank you for your response.