What the Bank of Mom and Dad should consider when dispensing money — especially if it might want to be paid back someday


Jason Heath: There are income tax, family law and estate planning factors to keep in mind when gifting or loaning money to your children

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A recent Abacus poll for the Ontario Real Estate Association found that 41 per cent of parents of children aged 18 to 38 chipped in to help finance their home purchase. Whether parents are gifting or loaning money to their children, there are income tax, family law and estate planning factors to keep in mind.

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There are generally no tax implications of giving cash to your children. Gifts to adult children are neither taxable to them nor subject to income attribution in Canada, though there may be gift or estate tax implications for U.S. citizens in Canada.

If you transfer an asset to a child that has appreciated in value, this may trigger a capital gain for you. Assets like stocks or real estate have a deemed disposition at their fair market value even if you gift them. If the asset subsequently produces income for your children, that income is taxable to them. One exception is with private company shares, as tax on split income (TOSI) rules may apply to subsequent dividends paid to your children.

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You do not need to charge interest on a loan to a child, but you can if you so choose. If you charge interest, you should set the parameters up front. One option might be to base it on the Bank of Canada prime rate, which is currently 3.7 per cent. This is a reasonably competitive interest rate that is in line with or cheaper than most line of credit rates.

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Interest paid to you on a private loan is taxable just as if you had a savings account or bought a GIC or bond. Even if the interest is accrued and not actually paid to you, it should be reported at least annually on the anniversary date of the loan.

Documenting a loan to a child has many benefits. It can help avoid a dispute later on which is important when you mix money and family. But there may also be benefits from a family law or estate planning perspective.

Property rights when a marriage breaks down are dealt with provincially. Several provinces have an equal right to possession of a matrimonial home for spouses. If a parent gifts funds that are used to purchase a home for their child and their spouse, there may not be protection in the event the relationship ends. If a loan is documented, a parent may be better able to keep the funds in the family.

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There can be other advantages to documenting loans to children. Tracking loans can help with estate planning. If you have more than one child and advance funds at different times or in different amounts, a loan agreement can ensure the loan is repayable to your estate and reduces a child’s inheritance accordingly. This can ensure an equal distribution amongst your children even if there have been unequal loans during your life.

If you make substantial loans, and you live in a province with high probate fees, you may be able to prepare multiple wills. Your primary will deals with assets like bank accounts and real estate that may be subject to probate. Your secondary will deals with assets like private loans that do not need probate.

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Another reason to document loans to children is in the event you need to call the loan. An example could be if you develop a health issue that results in significant long-term care costs. You may never require or request repayment, but it can be a safety net for a retiree who chooses to or is asked to provide financial support for a child.

Loans to children can also result in greater tax efficiency for a family. If your children have RRSP or TFSA room, lending them funds to make these tax deductible or tax free contributions can save a family tax. This is especially true if you have funds available in a non-registered account that is generating taxable investment income for you.

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If a parent helps a child by contributing funds for them to purchase a home, a mortgage lender often requires a gift letter. This letter requires the parent to confirm in writing that the amount is a gift to their child and does not require repayment. Lenders do this to ensure they are the only debtor that the borrower has to worry about making payments to each month. This may limit a parent’s ability to document a loan to their children.

No matter how much parents want to help their children to buy a home, it is important to consider that if a bank will not lend them enough to buy a home on their own, there is probably a reason for it. Their cash flow may be tight enough paying their mortgage let alone making any potential repayments to parents.

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Now that inflation is tracking nearly eight per cent year over year and there are risks of an economic slowdown as well, this could have a negative impact on over-indebted young homeowners. A higher cost of living coupled with a reduced income or job loss could cause a borrower to fall behind. Real estate prices are also starting to ease so even a slight decline could wipe out a new home buyer’s equity.

There can be benefits to gifting or loaning funds to a child during your life, when they are young and may need the money more, and you are alive to see it. Parents who are loaning money to their children should be careful about loaning more money than they themselves can afford to lose. They should also consider the income tax, family law, and estate planning implications to determine the best arrangement for them and their family.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

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