What’s the tax impact of a loan to my daughter?
AGREEMENT: HAVE DOCUMENT IN PLACE
Take out a life policy where your daughter is the owner, you’re the life assured and she pays premiums.
Areader Moneyweb asks:
I’m in the process of loaning money to my daughter, to build a house. How can I protect myself? There has to be a written agreement on the interest they’ll pay me monthly. They’ll pay back capital, but if they decided to sell the house, the capital I put in must come back to me. What’s the tax impact to me? I want to clarify that it’s not a donation but a loan.
NFB Private Wealth Management’s Stephen Katzenellenbogen answers:
I’m not a legal- or tax expert but hopefully have sufficient understanding of the dynamics to give you some guidance. The information provided below doesn’t constitute financial advice.
It appears there’s no obligation for you to charge interest on a ‘family loan’, but it’s certainly reasonable as you’re losing out on a return. Any interest received by you would be taxable.
The loan agreement itself should provide validity to the arrangement and it shouldn’t be viewed as a donation, whether or not interest is being paid. Here are a few points to consider: 1. The loan agreement should set out the repayment period, frequency and terms. You’ve already considered interest and the position if your daughter sells the property – both valid concerns. The agreement must stipulate the rate of interest. 2. Consider if the loan will be secured versus unsecured. The difficulty may come in if there’s a default. You could look at taking cession over the asset, if the agreement sets the property out as security – but the practical enforcement, given that it regards a close family member, may be difficult. 3. There could also be an unfortunate situation where your daughter is unable to pay the loan due to ill health, in which case you could include a guarantor. 4. Your last will and testament should include the loan (asset), adding credence to the loan agreement, and provisions relating to its recoverability.
You could bequeath the loan to your spouse if you’re the first to die.
You could bequeath the loan back to your daughter and the loan amount could be offset against other inheritances so other beneficiaries aren’t prejudiced. 5. An idea may be taking out a life policy where your daughter is the owner, you’re the life assured and she’s the premium payer. On your death the policy would pay out to her and provide the funds to repay the loan.
We’d suggest engaging with an attorney with the necessary skill and experience to draft the agreement, considering your specific needs, while alerting you to the various available options and pitfalls.