Clients who want to help their children buy a home have several options, each with its own tax implications.
Whether a client plans to give money, lend money, or co-sign their child’s mortgage, Susan Wood, director of wealth strategies with CIBC Private Wealth, said planning is required to make the most of their assistance.
When giving money, Wood said there are typically no tax implications for the children, but parents should be mindful of any tax consequences if the funds are sourced from investments or family trusts.
There are no immediate tax consequences for the children or parents when lending money to purchase a home. However, Wood said parents need to consider the source of the loan funds.
If parents lend money from their personal funds, they can choose to charge interest, which would be taxable income for parents at their highest marginal tax rate. Wood noted the interest paid by the children on the loan is not tax-deductible, as the home is being purchased for personal use.
“It’s taxable income to the parents, but it would not be tax deductible to the kids,” she said.
If parents decide to lend money from their private holding company or business, the company would need to charge interest at the prescribed rate to ensure the CRA doesn’t consider it to be a shareholder loan. Wood said seeking advice from tax advisors who understand the situation is crucial in this scenario.
Another way parents can assist their children is by co-signing their mortgage, Wood said, which allows children to benefit from their parents’ stronger credit rating, potentially securing a lower interest rate and more credit.
Co-signing allows parents to help their children without giving or lending money, avoiding the tax implications of cashing out investments.
“They may also like this approach because the expectation is that the child still pays for their own home,” Wood said. “They may like the discipline that this approach instils and the underlying lessons that their children can learn from paying off their own debt.“
However, clients should be aware that co-signing a mortgage means they’re responsible for the amount if their children fail to meet their payments, and their own credit rating could be affected. Co-signing may also limit the parents’ ability to borrow additional funds if they want to buy a recreational or investment property.
Withdrawal strategies for gifts or loans
When clients decide to give or lend to their children, from which accounts should they withdraw the funds?
“Draw down on your cash [and] near-cash balances, and then focus on non-registered funds with little or no gains, or gains that can be offset with other tax losses,” Wood said.
“Then consider taking funds from your private corporation to the extent that they have shareholder loan balances that can be drawn or positive capital dividend balances that will allow for a tax-free dividend.“
Drawing from a TFSA is the next best option, as there are no tax implications, but it results in a loss of tax-free growth on the withdrawn funds unless they can be re-contributed.
“Finally, non-registered funds with capital gains are still relatively tax efficient,” Wood said. “And then you can consider taxable dividends from your private corporation.“
As for using RRSPs or RRIFs, parents should think carefully. Withdrawals are fully taxable at the highest marginal tax rates, “so quite punitive,” Wood said. “And at the end of the day, [those accounts] are likely needed to support parents in retirement.“
Regardless of where the money is coming from, it’s important for clients to incorporate these gift or loan arrangements into their cash-flow plan, Wood said. Clients should be sure that assisting their children with a home purchase does not compromise their own retirement plans or desired lifestyle.
She said parents should also consider potential unforeseen expenditures and the possibility of extending the same assistance to other children. Parents may also want to consider ways to protect the funds in the event of a child’s divorce. This can get tricky, Wood said, and she recommends consulting a lawyer.
Estate planning should also be taken into consideration, as gifts made during a parent’s lifetime may lead to adjustments in the child’s share of the estate.
Using the FHSA
The new tax-free first home savings account (FHSA) has several advantages, Wood said, and allows clients to start gifting as early as their child’s 18th birthday.
Since the funds grow tax-free in the account, parents should consider annual gifts up to the $40,000 deposit limit rather than a lump-sum gift the year the child purchases a home, Wood said. That may allow parents to avoid investment income on the funds being taxed at their high marginal tax rate during those years, resulting in the funds not growing as quickly or efficiently.
Some parents may also find it easier to contribute smaller amounts annually, drawing from cash flow, instead of selling investments for a larger one-time gift, she added.
Wood also noted that children receive a tax deduction for the contribution.
“If they cannot use all or any of the tax deduction in the year that the contribution is made, because they happen to be in a very low tax bracket, they can carry forward the deduction to future years when they are paying higher taxes and can better utilize the deduction,” she said.