Co-Signing Loans for Family Members

“Ed” telephoned me the other day with a problem. “Craig” he said, “I have a bank coming after me for $200,000. Does my revocable trust offer me any protection?” 

I was surprised to hear that Ed was in financial trouble. As it turns out, it wasn’t Ed who caused the bank problem. I learned that Ed’s son, “Bruce” purchased a home five years ago, when Bruce was employed. In order to help Bruce qualify for the mortgage, Ed cosigned and personally guaranteed the mortgage note. 

You can guess what happened. Bruce lost his job. Bruce then fell behind with his mortgage payments. Ed decided not to help Bruce with the mortgage payments, which turned out to be a mistake since Ed co-signed the loan. The home was foreclosed. Since the value of the home hasn’t significantly increased, the foreclosure sale of the home brought an amount less than the outstanding balance of the mortgage. The bank therefore obtained a deficiency judgment against both Bruce and Ed.  

Since Bruce doesn’t have any assets, the bank is seeking recourse from Ed. The first I learn of this mess was Ed’s call to me asking whether his revocable trust somehow protects him against the bank. I advised Ed that his revocable trust does not offer any asset protection because he can freely do with the trust assets as he pleases. A revocable trust is simply another form of ownership. Since Ed can freely spend and consume his trust assets, they are not protected against creditors.  

Because of Bruce’s inability to pay the mortgage, Ed’s credit rating could also be adversely affected by these problems. 

Ed’s dilemma highlights an issue that many parents of adult children should consider before co-signing notes, and that is to determine what the worst-case scenario looks like, and whether that scenario could be financially devastating. 

In addition to the monetary losses Ed may have incurred, there could be gift tax repercussions to the guarantee Ed signed. While an old Tax Court case held that an agreement to guarantee the payments of another’s debts does not constitute a completed gift for purposes of the gift tax rules, the IRS position has in the past been that when a person guarantees the payment of another’s debts, the guarantor transfers a valuable property interest, and therefore a completed gift has occurred. 

A controversial 1991 Private Letter Ruling, for example, held that a guarantee is a completed gift, although no guidance was provided suggesting what the value of such a guarantee might be. The IRS cited a Supreme Court decision Dickman v. Comr., a 1984 case that held a parent’s agreement to guarantee payment of loans conferred a valuable economic benefit to the child; as without the guarantee, the child may not have obtained the loan or would have had to pay a higher interest rate.  

This controversial ruling has since been withdrawn without IRS comment. However, the IRS may maintain the position that if the child defaults on the loan and the parent repays amounts under the terms of the guarantee, additional gifts are made to the extent that the parent is not reimbursed by the child. 

With today’s $11.4 million gift and estate tax exemptions, making a taxable gift might not result in any estate taxes. The current exemptions sunset in 2025 absent any further action by Congress, and it is entirely possible that following the 2020 general election the tax law changes anyway.  

In Ed’s case this could constitute additional heartache. Not only may he be required to step in to cure the deficiency on the mortgage foreclosure, he may also lose some of his lifetime gift tax exemption. 

The bottom line is that one should tread cautiously when cosigning or guaranteeing family obligations. 

©2023 Craig R. Hersch. Learn more at 

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