Doesn't this still require them to charge market rate interest though? And wouldn't the OP still need to qualify for the mortgage with their limited student income? I'm curious how this would work practically.

The IRS only requires what's called the Applicable Federal Rate (AFR) for family loans, which is typically much lower than market mortgage rates - sometimes less than half. In January 2025, the long-term AFR is only around 3.4% while market mortgage rates are over 6%. Regarding qualification, that's the beauty of a private family loan - there's no formal qualification process like with a bank. The grandparents can set whatever terms they're comfortable with based on their knowledge of the grandchild's situation and future earning potential. Many families set up lower payments during school years with a balloon adjustment after graduation when income increases. The biggest tax advantage is that the grandparents can spread any capital gains across multiple years rather than recognizing it all in one tax year, potentially keeping them in a lower tax bracket. Meanwhile, the grandchild can still deduct the mortgage interest just like with a traditional mortgage.

Couldn't they just use a life estate deed? That way the grandparents retain the right to live in the property until death, but ownership transfers automatically at death - getting the step-up in basis benefit while still guaranteeing the property goes to the grandchild?

A life estate deed is definitely worth considering, but it has some limitations. While it does allow for the step-up in basis at death and avoids probate, there are a few important considerations: The grandparents in this case don't actually live in the property (OP mentioned it's their "2nd house"), so a traditional life estate might not make sense. Instead, they might consider a remainder interest deed with retained right of sale, which would still provide the step-up in basis while giving them flexibility. Another potential issue is that creating a life estate now could trigger gift tax consequences on the remainder interest (the portion effectively being given to the grandchild). The IRS has specific formulas to calculate the present value of that remainder interest based on the life expectant's age. Also worth noting that with a life estate, the original owners can't sell or mortgage the property without the remainder beneficiary's consent, which may or may not be desirable depending on the grandparents' future needs.

I didn't even think about that! I do have both traditional and Roth 401k options through my employer. I'm going to check my pay stubs right now to see if I was contributing to both. Looking at my December pay stub, you're absolutely right! I had set up automatic contributions to both accounts. The $1100 in Box 12 with code AA is just my traditional 401k contribution. The Roth portion would be recorded differently. Thank you for pointing this out - it really helps clear things up!

This is a really important point. My brother claimed HoH because he pays over half the costs for our mother's nursing home

Yes! This happened to me too. My statement showed nearly $2k more than my W-2 Box 12 code AA amount because the statement was including the investment returns for the year. The actual contribution matched my W-2 when I looked at just the contribution section of my statement.

But how do you PROVE you sold for less than you paid when you don't have receipts for clothes you bought years ago? Seems like the IRS could just assume it was all profit.

You don't necessarily need original receipts. The IRS understands that people don't keep receipts for clothing purchases from years ago. You can make reasonable estimates based on the type and brand of clothing. For example, if you sold a Nike hoodie for $30, you could reasonably estimate you paid $60-70 for it new. Document your estimates in a spreadsheet with descriptions of each item. The burden of proof for personal items sold casually isn't as high as for business inventory. Just be reasonable and consistent in your approach.

Yep, happened to me too. But you can deduct the shipping costs as expenses on Schedule C. Just keep track of what you spent on shipping for each item. I created a simple spreadsheet with item sold, sale price, shipping cost, and estimated original purchase price.

Does making those "good faith" payments actually work though? Like, do they really care about the effort or do they just calculate the penalties strictly by the numbers?

In my experience, making good faith payments absolutely helps. While the penalties are calculated mathematically, having a history of attempting to comply can help if you ever need to request penalty abatement. The IRS has a First Time Penalty Abatement policy that's easier to qualify for if you show a pattern of trying to comply. The other practical benefit is psychological - making regular smaller payments is much less painful than facing a huge tax bill plus penalties all at once. Even if you underpay somewhat each quarter, you're still reducing the base amount that penalties are calculated on, which saves money in the long run.

TurboTax Self-Employed can handle Form 2210, but it's not great at explaining the annualized income method. I used it last year and still ended up confused about whether I was doing it right. If your situation is straightforward it might be fine, but with variable income throughout the year, I'd recommend getting some help.

What about equipment I bought for my business that I could still sell if the business fails? Is that still considered "at risk"?

Yes, that equipment is still considered "at risk" even if you could potentially sell it later. The question is really asking if you could potentially lose the money you invested, not if you definitely will lose it. For example, if you bought a $2,000 computer for your business, it starts depreciating immediately and you might only get $800 if you had to sell it used. That potential for loss makes it "at risk." The IRS is trying to distinguish normal business investments from certain tax shelter arrangements where investors are protected from any possibility of loss.

Did you have to file an amended return or was just responding to the letter enough?