Periodic insights from our Investment and Private Client Teams on a broad range of investment and advice-related topics
Published by the Private Client Team at KJ Harrison Investors
With interest rates rising, the housing market seems to be in a state of flux. The direction of housing prices – up, down or sideways – is a hot topic of conversation around dinner tables and office watercoolers, which is hardly surprising given how much wealth Canadians’ have tied up in their homes. Yet despite all the uncertainty, for would-be homeowners the reasons to buy real estate remain strong, including the long-term investment potential and the emotional satisfaction of owning one’s own place. That’s especially true for young people, who see buying a home as not just a way to keep a roof over their heads, but also as a milestone in their career and family journey.
The challenge for young people, of course, is affordability. Housing prices remain near historical highs, even though they have moderated slightly since the Bank of Canada began raising rates earlier this year. So, many young couples and individuals (there is no firm data on just how many) turn to their parents for financial help – a phenomenon captured in that now-well-worn phrase, “the Bank of Mom and Dad.” In our experience as financial management advisors for high-net-worth individuals, we have found that “Mom and Dad” are usually more than willing to lend a hand. (In fact, one report from 2021 found that high-net-worth parents gave each of their children $145,000 on average to buy their first home.) Many of the parents we work with know that they will have a legacy to leave their children, and they often prefer to see some of the money put to good use while they are still alive. The question on their minds is usually not whether they should help their kids buy a home, but how they can best go about it.
It’s an important question, because giving or lending money to your children for them to buy a home can have legal and tax implications; when done without sensitivity or a sense of equity, it can even impact family relationships. So if you are the manager of the Bank of Mom and Dad (or just of the Bank of Mom!), here are a few options and issues to consider:
- Is your child taking advantage of tax-mitigating saving strategies?
In its 2022 budget, the federal government unveiled a new program called the Tax-Free First Home Saving Account (FHSA), which gives first-time homebuyers another tax-mitigating option when saving for a down payment. Basically, you can contribute $8,000 a year to an FHSA to a maximum of $40,000, and the contributions are deducted from your annual income. Transfers from an existing registered retirement savings plan (RRSP) are also allowed. Then, if you withdraw from the FHSA to buy a first home, you don’t pay any tax. Nor do you pay tax on any capital gains or interest earned from the money invested within the FHSA. (Withdrawals for purposes other than buying a first home are taxable, however.)
Effectively, the FHSA combines the benefits of an RRSP and a tax-free savings account (TFSA) into one program, which makes it a potentially powerful savings option. And it is unlike the existing Home Buyer’s Plan, which allows tax-free withdrawals of up to $35,000 from an RRSP if the funds are used for a home purchase but also requires that the money withdrawn be paid back into the RRSP over time.
For parents considering helping their kids out with a down payment, one possibility is to gift funds for the child to contribute to their FHSA. Gifts are tax-free anyway, but the child would benefit from the ability to generate capital gains or interest within the FHSA tax-free as well, potentially allowing them to make a larger down payment in future.
- Should you just give them the money?
Gifting money to your children is the simplest way to help them afford a first home, and it has the added benefit of having no tax implications. There is no gift tax in Canada, so any money you give to your children will not count
towards their income (or be deducted by you as an expense). However, gifting money could have unforeseen consequences down the road. If, after using your gift to buy a home, your child’s marriage breaks down, the money you gave for the down payment could be considered part of the marital estate by a divorce court. If it is, then your child’s ex-spouse could be deemed entitled to half of it.
- Should you lend the money?
One option that will mitigate risk to your family’s capital is to structure financial support for your child’s home purchase as a mortgage. Because the mortgage is a debt, it will have to be repaid (back to you) upon the sale of the property. So, if we consider the above example of what could happen in case of a marital breakdown, there would be no payout to your child’s ex-spouse because the funds you lent would be repaid upon sale of the house. One wrinkle to this option, however, is that your loan might affect your child’s eligibility for further financing (including other mortgages) and their debt-service ratio, making it harder for them to borrow more money should they need to.
- Can you give them your house?
Many parents consider downsizing or moving just for a change at around the same time as their children are starting out with career and family – and looking to buy their first home. Gifting your principal residence to your offspring can help preserve the emotional value of the family home, and as long as you own the home outright, no capital gains or land transfer taxes apply. Obviously, this is not an option in every circumstance, but if the timing works for you, it can be an attractive one.
In short, you have plenty to consider when it comes to supporting your child in the purchase of a home – there is no one right way. But there are some wrong ways, and one of the most hazardous occurs when parents play (or appear to play) favourites. Gifting or lending money has an impact on your estate, and if you have more than one child, you should consider what adjustments you need to make to your estate plan in order for it to remain fair. Then, you should consider how you are going to communicate your decision to all impacted family members. In our experience, clear communication is key to getting through the process with family harmony intact.
If you would like to learn more or discuss your options, please contact us at https://kjharrison.com/contact/