Hello,
My husband and I are in the process of purchasing a home for $150,000. My parents are loaning us the money to do so. Mom and dad recently sold their home and had put the proceeds into a liquid account. They were making less than 1% interest on this account. This has created a “win win” situation, in which they would loan us some of this money so we can buy a house and then they get a better ROI on their money. Mom gave us a $12,500 check and dad gave us another $12,500 check as gifts, then they gave us a $125k check, which is the loan amount. We have come up with a promissory note showing the payment schedule on the $125k loan. Their CPA recommended that they charge us an interest rate at the prime rate or higher. We settled with 3.25% over a 20-year term. The note has been signed, witnessed and notarized and includes the amortization schedule and a copy of the survey. If all goes well, mom and dad will continue to give us financial gifts each year to help us pay down the loan. My husband and I will start monthly payments on 7/1/11. My questions are these:
1) Have we got everything covered for this to be a legitimate transaction in the eyes of the IRS? If not, what are we missing?
2) Would my husband and I be able to deduct the interest on this loan? If so, what else do we need to do to make sure we can do this? What would my parents need to do on their end? ...or are we better off not reporting anything at all???
3) Does anyone have any better suggestions as to how to best handle this personal loan?
4) On top of this, we plan on renting our current home to my mother-in-law at a greatly discounted rate using a basic rental agreement. Not sure if this changes anything or not, but wanted to mention it nonetheless.

We are having trouble getting consistent answers/advice, so thanks very much in advance for your help!