My wife and I have been gifting "Mom" enough money to make her mortgage payments ever since she retired a few years ago, and we plan to continue doing so for the indefinite future

Bad plan.

I've been thinking, wouldn't it be better all around if we loaned her enough money to pay off the mortgage at essentially zero interest, since we were planning to help her make the mortgage payments anyway? Of course we would want such a loan to be documented in a way that it gets paid in full if she sells the house -- does that make it a mortgage?

Another bad plan. This one will not only prevent you from making money with the money but it could trigger an IRS audit of your mother and yourselves, and you could find yourselves being forced to pay tax on interest income that you aren't receiving. IRS won't let you do this kind of deal; you have to charge a "fair rate" on the interest.

It gets better. When you inherit, the money you have given your mother becomes part of her estate, and you become liable for any taxes on the inheritance. Furthermore, if your mother becomes ill, she could lose the house and it would pass out of your family.

In your position, I would buy the house from Mom. I would then write her a lease that gave her right of occupancy for her entire life (thus protecting her) revocable only by mutual consent. I would then charge her a fair market rent, using her proceeds of the sale of the house to fund it.

The house then becomes a rental property, which you depreciate. The rent she pays you has the effect of gradually transferring her estate to you in a fashion that is legal and tax free (the depreciation allowance should about take care of the rental income), and yet she continues to live there. Not only that, but as her landlord YOU become responsible for maintenance - which undoubtedly your mother would appreciate.

Should she become seriously ill and need extended (and expensive) medical care, she won't lose her house because it is YOUR house. If she becomes destitute as a result of her need for care, Medicaid won't be able to sieze the house, since this is a completely above-board transaction. You would need to continue to charge her rent, even if she was broke, in order to maintain the rental property status with the tax shelter that represents, but in that event you could gift her the money she needed to pay the rent. Kind of roundabout, but legal.

This is a win-win situation. She keeps her home under virtually any circumstances (unless you go under financially), and you not only have an appropriate return on the money you put up, but you gain an asset legally and without any negative tax consequences.

About the Author: Jim Locker is a technical guy who has done a lot of real estate investing and landlording. The experiences he writes about and advice he gives are either first hand, or in answer to specific questions posed by others. He is commonly known as jiml8 around the internet.