Frequently, parents (and possibly grandparents) help their children (grandchildren) with the purchase of a home. This can happen, for instance, if the children have income too low to qualify for a loan or have a credit record that precludes them from getting a loan at all. The parents initially make or supplement the payments on the home until the children can afford to assume the entire financial obligation on their own. The downside of these arrangements is that they can give rise to financial and tax complications depending on how the payments are handled and how the family members hold title to the home.

Tax law specifies that mortgage interest and taxes may be deducted only if paid by the person claiming them AND that person has some ownership interest in the property. This rule can have some serious ramifications. Suppose parents hold title to a home occupied by their children, but the children make the house payments. In this case, the children can't claim the mortgage interest since they do not own the property; the parents can't deduct the interest either because they didn't pay it. If the children had been on the title for even a small percentage of the property, they would be able to deduct the interest and taxes.

For parents to qualify for interest deductions on a home their children live in, they must make the mortgage payments and must designate that home as their second home. A taxpayer can only designate one second home for tax purposes, so if they are also helping other children buy a home or already have a second home of their own, they could lose out on deductions of interest paid on certain of the properties.

Problems with the lender can come up when it's time to transfer title of the home to the children. For example, when a mortgage has an assumption fee, the children would be required to qualify for the loan on their own and pay the fee. Alternatively, a loan may have a due on sale clause, so even quitclaiming a house to children would make the mortgage due and payable in full.

Lastly, purchasing a home with children may cause some gift tax implications when the time comes for the children to take over full ownership of the property. For 2010 and 2011, each individual is permitted to give annual gifts valued up to $13,000 each to as many recipients as they wish without affecting their lifetime gift and estate tax exclusion. The parent's share of the home equity will be counted as a gift when the property is transferred. If there are two parents, they each can give $13,000 to the child, raising the total to $26,000. If the child is married, each parent may also give $13,000 to the child's spouse, raising the total to $52,000.

The only way to guard against hassles like those mentioned in home purchase transactions with someone else is to do your homework well! Tax planning is definitely needed to avoid the traps.