Jonathan Chevreau, Finan­cial Post

Many Baby Boomers have paid-for homes, while their grown chil­dren are con­tem­plat­ing enter­ing the hous­ing mar­ket. Instead of let­ting them rent dur­ing their first foray after leav­ing the nest, it’s tempt­ing to buy a sec­ond “invest­ment” prop­erty with Junior as the main tenant.

Fully 10% of Cana­dian par­ents are con­sid­er­ing this, accord­ing to TD Canada Trust, but you need to be aware of the full tax and estate-planning consequences.

There are at least four options, accord­ing to char­tered accoun­tants Kathy Munro and Caryn Walt, who wrote an insight­ful analy­sis in the Win­ter 2011 edi­tion of Price­wa­ter­house­C­oop­ers’ Wealth and Tax Matters.

Using the exam­ple of a $250,000 condo, Option 1 is buy­ing the condo in your own name and hav­ing the child pay you rent. Assume the par­ents are in the top 46% tax bracket. But if they already have a prin­ci­pal res­i­dence for tax pur­poses, any cap­i­tal gains on the sec­ond prop­erty — the one being rented by the child — will not be tax-free for the parent/owners.

You and your spouse are con­sid­ered one fam­ily unit, which gets only one prin­ci­pal res­i­dence. So if the condo rises to $450,000 at your death (or sale) the cap­i­tal gains tax will be $46,000 (half the $200,000 gain x 46%). The condo will also be sub­ject to pro­bate fees as high as 1.5% in Ontario or 1.523% in Nova Scotia.

Option 2 is gift­ing cash of $250,000 to the child, who buys the condo in their own name. This has no imme­di­ate tax con­se­quences but can cre­ate prob­lems with sib­lings who may nat­u­rally desire an equal por­tion of the ulti­mate inher­i­tance. Tax-wise, though, this condo becomes the child’s prin­ci­pal res­i­dence, which means tax-free cap­i­tal gains if it rises in value over the years. And because the par­ents don’t own it, there will be no pro­bate fees upon their death. The down­side comes if the child gets mar­ried then divorces. Under equal­iza­tion laws, he or she may lose half the value of the condo to the depart­ing spouse.

Instead of pro­vid­ing an out­right gift, Option 3 is to set up a mort­gage so the child buys the home and pays you back through a nor­mal amor­ti­za­tion sched­ule. The loan is interest-free because any inter­est paid by the child is tax­able in your hands and the child can’t deduct the inter­est on his or her own tax returns. The child can pay back the prin­ci­pal or the mort­gage can be left out­stand­ing, pro­vid­ing bet­ter pro­tec­tion if a divorce occurs while own­ing the condo. There may be pro­bate fees but as with Option 2, the child takes advan­tage of the prin­ci­pal res­i­dence exemp­tion. This is the most pop­u­lar option, Ms. Munro says.

Option 4 is cre­at­ing a dis­cre­tionary inter­vivos fam­ily trust to acquire the condo on behalf of the child. Since par­ents act as trustees, they retain legal con­trol over prop­er­ties set aside for their ben­e­fi­cia­ries: the chil­dren. The child can­not des­ig­nate another prop­erty as a prin­ci­pal res­i­dence dur­ing the years the trust owns the condo. This option is more com­plex and costs a few thou­sand dol­lars to set up but pro­vides more flex­i­bil­ity for the chang­ing needs of the child — the ben­e­fi­ciary who ulti­mately receives the condo or the pro­ceeds from its sale can be deter­mined by trustees in the future.

Jamie Golombek, man­ag­ing direc­tor, tax, with CIBC Pri­vate Wealth Man­age­ment, favours a zero-interest mort­gage, which is “easy, tax-effective and guar­an­tees mom and dad can get their money back should they wish.”

Alter­na­tively, you could waive prin­ci­pal repay­ments dur­ing the course of the mort­gage; ulti­mately, the par­ents for­give the debt entirely, essen­tially gift­ing the loaned funds to the child.

Real estate author Don Camp­bell says out­right gift­ing doesn’t teach kids any­thing, so par­ents often lend them the funds to buy a home in the child’s name.

They may not charge inter­est but want their prin­ci­pal back, espe­cially if retire­ment is looming.

He sug­gests mak­ing the arrange­ment a “teach­able moment” by for­mal­iz­ing a joint ven­ture between par­ent and child in writ­ing. You can down­load a tem­plate free from his web­site at http://​myrein​space​.com.

That way, “we give the kids a hand up and get our money back.”

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Con­tact the Jef­frey Team for more infor­ma­tion – 416−388−1960

Lau­rin & Natalie Jef­frey are Toronto Real­tors with Cen­tury 21 Regal Realty.
They did not write these arti­cles, they just repro­duce them here for peo­ple
who are inter­ested in Toronto real estate. They do not work for any builders.
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