Helping out the kids – loan or gift?
This issue came up in a recent client meeting, and it was a great reminder about the importance of getting the structure right when dealing with financial assistance between family members, given the prevalence of parents assisting their children with purchasing a first home.
A number of issues should be considered in relation to optimising tax exemptions and asset protection, as well as documenting the true intention of the arrangement to minimise misunderstandings down the track. While the optimal structure often requires a balancing of competing objectives, I’ve set out some general rules of thumb to assist with choosing the best structure for documenting intra-family financial assistance.
First rule – Tax
It is often prudent for the child to purchase the home in their own name so they can access the principal place of residence capital gains tax exemption on disposal of the property. However, acquiring the property this way can expose the funds contributed by the parents to the child’s relationship breakdowns or bankruptcy risks. If the asset being purchased is not a family home, then there may be other optimal structures, such as a family trust, which would be more appropriate.
Second rule – Document the intention
It is essential that the family understands and documents whether the contribution is a gift or a loan. In particular, if the child believes that the contribution is a gift and has no intention of paying it back, however the parents believe it is a loan and expect repayment during their lifetime (or under their will), then tensions are bound to arise. Entering into a short written agreement confirming whether the contribution is a gift or loan is a very simple process which can remove much of this white noise.
Third rule – Protect the equity
Even where there is a general intention that the financial assistance will not be repaid, for many families it makes sense to require that the contribution is repaid if there is an external event such as divorce or bankruptcy which would result in the equity in the property ending up in the hands of a third party outside the family.
To protect against that outcome it is possible to document the contribution as an interest-free loan, ideally with security granted in favour of the parents over the home (either as a first mortgage or a second mortgage if there is also an external financier). Only nominal repayments need to be made to maintain the status of the loan, but if the child does experience a relationship breakdown or bankruptcy, then the parents will have priority for their contribution to be repaid ahead of the spouse or creditor, ensuring that the family retains the benefit of the initial capital contribution.
Consideration should also be given to the appropriate entity for making the financial assistance. If either parent has any exposure to bankruptcy, then they should consider contributing the amount initially to a properly structured family trust, which would then make the loan. Taking this extra step protects the right to repayment from the parents’ creditors.
If this situation has come up for any of your clients, please get in touch – it is a straightforward process to document the relevant arrangements (whether by deed of gift or loan agreement and mortgage) which can save much angst in the long run.
And as always, if your clients have given financial assistance to their children during their lifetime, it is critical that they review their estate planning documents to confirm what happens with those amounts on death and whether any equalisation is required for other children.
And for those with a keen eye – the cover photo is a picture of me with my own wonderful parents on my graduation day!