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Susan Wood, director of wealth strategies with CIBC Private Wealth.
Parents can help their children buy houses in a number of different ways. They can do so by gifting them the money or lending them the money, or they may choose to help their children get financing by co-signing their mortgage. Each of these have their own tax considerations, and I’ll just run through them quickly.
If we first look at gifting them money to help with the purchase, with the initial gift itself there generally are no tax implications to the children or the parents from the gift. There may however be tax implications to the parents depending on where they source the funds to make the gift in the first place. For instance, if they have to sell in investments. In some cases for wealthier, more affluent parents, if the funds are being gifted to the children from a family trust, for instance, that the parents may control, there may be tax implications to the children. But these are very special circumstances that should be considered in discussion with your tax advisor.
If we look at lending them the money, like with gifting, there are no tax implications to the children or the parents from the extension of the loan itself. However, there may again be tax implications to the parents depending on where they get the funds from to make the loan in the first place. If parents lend money to their children from funds that they hold personally, the parents can decide whether to charge interest or not on the loan. If interest is charged, the interest will be taxable income to the parents and that will be taxed at their highest marginal tax rate. Because the loan is being used to purchase a home for the children’s personal use as opposed to if they were buying a rental property, the interest that the children pay on the loan will not be tax deductible to them. It’s taxable income to the parents, but it would not be tax deductible to the kids.
Then finally, if parents choose to lend the money to the children from their private holding company or a business, if that happens to be where they hold their investments, the holding company will need to charge interest at the prescribed rate loan that CRA prescribes on a quarterly basis, because we don’t want CRA to consider this as a shareholder loan. There are all kinds of negative punitive benefits there. Parents would have to consult with their tax advisors who understand the particulars of their situation. They may also want to consult, if they’re considering a loan, they may also want to consult with a lawyer and consider whether formalizing the loan with documentation and even registering a charge against the home is advisable. Each situation is different.
Then the last kind of way that you can help your kids buy a house is by co-signing a mortgage. By cosigning a mortgage, parents are basically allowing their kids to leverage the parents’ stronger credit rating, meaning they may get a lower interest rate and they may get access to a higher amount of credit.
Many parents like this approach. It’s not for everybody, but some do. One, it doesn’t require them to give away or lend out their capital, which they may not be able to give or they may have need of. Even if they do have the capital, they may not want to free it up by means of cashing out investments if they’re concerned about there being tax implications and whatnot. They may also like this approach because the expectation with this approach is that the child still pays for their own home. They may like the discipline that this approach instills and the underlying lessons that their children can learn from paying off their own debt.
Parents should keep in mind that if they do co-sign a mortgage, they are on the hook for the full amount should their children not meet the mortgage payment commitments. Further, if the child defaults on payments and parents aren’t aware, the parents’ own credit rating could be at risk. Then finally, co-signing for a mortgage may limit the parent’s own ability to borrow additional funds should they need to do that down the road, say, to purchase a recreational property or for another private investment down the road.
Where should parents draw funds from? Parents will want to consider carefully where they draw funds from because there may be different tax implications depending on the source. If they have cash or near cash sitting around, there may be little to no tax implications to the parents on drawing down these funds. If the parents are drawing down from their TFSA, there will be no tax implications as funds can be drawn tax-free. However, there will be a loss of tax-free growth on those funds going forward unless the parents can re-contribute the capital to their TFSA in the following year, let’s say.
If the parents have to sell investments, there may be tax implications to the extent that the sale of the investments triggers gains. For parents that hold investments in a private holding company or corporation, there will be a tax implication depending on how they take out the capital from the company. If they have to take it out by way of a dividend, it will be taxed unless they’re able to take it as a tax-free capital dividend. Or they may be able to draw down on a shareholder loan balance on a tax-free basis if they do have one. Parents will want to consult with their investment advisors and their tax advisors depending on the complexity of their structure so that they can be sure to minimize the tax implications of freeing up the capital to make the gift or the loan.
In short, they will want to prioritize tax resources of capital. Draw down on your cash, 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. 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.
Then consider tax-free savings account. Finally, non-registered funds with capital gains are still relatively tax efficient, and then you can consider taxable dividends from your private corporation.
Final thing I’d say on this is that you should think carefully before drawing down on RRSPs or RRIFs since these withdrawals will be fully taxable at the parent’s highest marginal tax rates, so quite punitive, and at the end of the day, they are likely needed to support parents in retirement.
In terms of incorporating planned giving to your children as part of your financial plan, if parents are considering gifts or even lending funds to their children, they should be doing so with the full knowledge that they can afford to do it. Understanding the tax implications of how the gift or loan will be funded is a first step, and then incorporating this into a full cashflow plan will be key so that you can ensure that making this gift or loan or even cosigning a loan along with any potential tax implications, will not compromise your retirement plans and your ability to maintain your desired lifestyle, as well as deal with any unforeseen or unexpected expenditures that may arise down the road.
Also included in this cashflow plan should be the possibility that parents will want to extend the same gift or loan arrangement to their other children if they have more than one, and if their objective is to gift each child with the same advantage.
Another planning consideration that parents may want to think about is thinking about what they can do to add some protection around the gifted funds, whether that be to shelter the funds from potential creditor claims if their kids happen to be employed as a contractor or as a lawyer for instance, or more typically from potential family law claims. We never want to think about it, but the statistics show that there’s always a risk of marital or common law relationship breakdown. You can add some protection around the funds that you are gifting by documenting it as a loan to your child so that if there is a marital breakdown, you can demand repayment of the loan rather than losing half of it or potentially losing half of it to your child’s ex-spouse or partner. This of course, is a very tricky area to navigate for many reasons, and you should absolutely consult a lawyer to discuss the merits of this strategy as it relates to your particular situation.
Another tact may also be to require your child to enter into a form of family law agreement with their partner prior to extending the gift or the loan, particularly if it’s a significant amount. Whether that be a pre or post-nuptial agreement or a cohabitation agreement, I have seen instances where parents require that such a family law agreement be entered into prior to a significant gift being made. Again, consulting with a lawyer with specialty in this area is key.
Then finally, from a planning perspective, this gift or loan may impact your estate planning. Parents may want to give some thought as to whether the gift they make to their child during their lifetime will be considered as an adjustment to their child’s share of their estate and whether that should be reflected in their wills. For instance, if you’ve made a gift to one of your children but not to others, will you want to adjust your child’s share of your estate as an equalization measure?
The First-Home Savings Account is an excellent savings vehicle for your children who plan to eventually purchase a home. It can be a smart investment tool even if the child is not sure of purchasing a home down the road. If as a parent you know that you want to help your child with a gift to purchase a home, a First-Home Savings Account can allow you to start gifting sooner, potentially as soon as your child turns 18. The maximum lifetime contribution to a person’s First-Home Savings Account is $40,000 with 8,000 of annual contribution room starting in the year the First-Home Savings Account is first opened. First opportunity to do so is in 2023, given the recent budget announcement.
Rather than gifting 40,000 in the year that your child purchases a home, you can potentially start gifting your child 8,000 annually for five years once they turn 18, to fund their First-Home Savings Account contributions. The tax benefits include the funds growing tax free as soon as they are in the First-Home Savings Account, whereas if as a parent you held onto them personally until your child purchased a home, the investment income on the funds would be taxed at the parent’s high marginal tax rate, resulting in the funds potentially not growing as quickly or growing as tax efficiently.
Next, your child gets a tax deduction for the $8,000 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. In fact, they can carry forward the deduction to years even after the First-Home Savings Account has been closed, perhaps because they’ve made the purchase of their first home, so efficient use of that tax deduction spread out over potentially a long period of time. Because the parent is giving $8,000 per year, it may be easier for the parent to fund the gift from cashflow rather than having to sell investments, for instance, if they were to make a larger one-time gift down the road. That can be very appealing to parents.
Then finally, your child has up to 15 years to use the funds to purchase a home. The 15 years starts from when the First-Home Savings Account is actually opened. If in 15 years time they still have not purchased a home, they can contribute the balance that’s in the First-Home Savings Account to their RRSP. Either way, the parent has the comfort of knowing that their gift will be used for the long-term benefit that they’d hoped for.