My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, March 25, 2013

Formalize Housing Loans to Your Married Children!

In this day and age of skyrocketing housing prices, it's not unusual for parents to provide their married children with a loan to assist them in purchasing a home. In many cases, a mortgage as opposed to a loan would be the preferable legal avenue. However, today I am restricting the discussion to housing loans to make you aware that even when a loan is formalized, it may not protect a family's financial interest when a child's marriage falls apart.

Many parents are savvy enough to legally document housing loans to their children, whether the loan is interest bearing, interest free or in some cases, essentially a forgivable loan. Nevertheless, despite the parent’s best intentions, if their child divorces, there is a chance that the parent’s loan will not be considered a valid debt for purposes of the Ontario Family Law Act (FLA). This can happen if there are no actual physical cash payments made on the loan, (amongst other criteria), which one would expect to see with a typical loan. As I am not a lawyer, I cannot comment on how similar or dissimilar the Ontario Family Law Act is to Acts in other provinces.

Where a loan is not considered valid under the FLA, the principal may be significantly discounted, or excluded as a debt for purposes of a child’s net family property which impacts the equalization payment upon divorce. In plain English, a child will not be able to reduce his or her assets on the date of separation by the debt obligation to his/her parents. This results in a greater amount of assets that must be split with their ex-spouse.

Lawyers drafting a debt document typically ensure that the loan has an interest rate, as well as default and payment terms, to establish the debt is bona fide. I briefly discussed this housing loan issue in a March 2011 blog post on prenuptial agreements. You may wish to review the blog to provide you with some prenuptial advice for your children. In a perfect legal world, where parents know they will fund the matrimonial home, a prenuptial agreement would be executed to exclude the matrimonial home. However, in the real world, when love is in the air, that is a rare occurrence.  

The decisions in the two cases below, provide impetus for parents to ensure any loans provided (at least in Ontario) to their children are valid. 

Case 1 – Poole v. Poole


In his 2003 paper "I Love You Son, But You Owe Me! - Gifts & Loans from Parents to Children”,  Brahm Siegel reviews the 2001 case of Poole v. Poole. In this case the court reduced the value of the debt a son owed his parents by 90%.

The facts of this case were as follows. The husband’s parents advanced $80,000.00 to the couple over the course of their marriage. Three promissory notes were signed by the couple. The money was used to help them acquire and pay off mortgages on various homes they owned during the marriage as well as pay off family debts. After they separated, the parents sent a letter to their son and his estranged spouse demanding repayment of the loan. They then sued both and the lawsuit was consolidated with the parties’ matrimonial litigation. The judge found the promissory notes constituted debts on behalf of both parties and should also be discounted by 90%.

Mr. Siegel summarizes why the courts found it “highly improbable” that the parents would ever call on the husband to pay his half of the debt.

The court’s findings were as follows according to Mr. Brahm:

1. The debts were 11 and 17 years old;
2. The parents never demanded payment except for the demand that led to the litigation which was motivated by a desire to collect from the wife;
3. The parents advanced the money to the parties to help them out and it was not anticipated it was to be repaid until they could afford it and until the parents needed it;
4. The husband’s mother admitted that but for the separation they would not have demanded payment and commenced the litigation;
5. The husband had not made any payments on the loan since separation.

However, because the court could not say with certainty that there was no possibility whatsoever of the husband having to repay, the value of the debt was reduced by 90%. 

Case 2 – Cade v. Rotsein


In a blog by family lawyer Andrew Feldstein, he discusses a similar case, Cade v. Rotsein. Mr. Feldstein wrote the following summation of the case.

“In the case of Cade v. Rotstein, 2002, affirmed on appeal 2004, the Husband claimed that advances totaling some $200,000.00 made to him by his parents during the course of his marriage to the Applicant constituted loans. The advances were made over a period of approximately 13 years to assist the Husband and Wife in their acquisition of family residences and were captured in promissory notes signed by the Husband. […] Specifically, he noted that a debt serves to reduce the debt claimant’s net family property such that any equalization payment the spouse, who claims the debt, may owe the other will accordingly be reduced (an equalization payment is defined as one half the difference between the parties’ net family properties). The trial judge then went on to adopt the approach endorsed in the earlier case law: the value of the debt to be attributed to the debt claimant should be discounted to reflect the reality of whether the claimant will be called upon to pay the debt. Based on the facts before him – the debts were old and no demand had been forthcoming on these debts prior to the separation of the Husband and Wife and the Husband’s father testified that he would not look for the money nor take legal action against his son to recover the money – the trial judge concluded that only 5% of the face value of the debts should be included in the Husband’s net family property.”


Mortgage and Promissory Note Limitation Periods


Another issue to consider is that when you execute a promissory note or obtain a mortgage there are various limitation periods that can nullify these documents. It is possible that if a limitation period has expired, the loan or mortgage will not be legally enforceable and the child may not be able to deduct the loan/mortgage from their net family property.

In summary, it is imperative that parents get proper legal advice to understand how to ensure a loan will be a valid debt (which may require the child to repay some of the loan each year and/or pay interest on the loan) under the FLA (at least in Ontario) and will count as a reduction of the net family property of their child. I have confirmed with a family lawyer that these older cases are still considered valid and care must be taken in regard to family housing loans.

Bloggers Note: I am not a family lawyer. This blog post should not in any manner be considered as legal advice. This post is a warning for any parent considering making a housing loan or for any parent who has already made a housing loan, to seek legal advice. 

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

18 comments:

  1. Fascinating! It really shows that these aren't agreements to be entered into lightly. I'm glad to see that the courts recognized people trying to use them as bargaining chips/tools of punishment.

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    1. Thx Kevin:

      Your opinion seems to come from a position as a neutral observer. I am not sure if you loaned your hard earned money to one of your children and you lost half of it, you would be as magnanimous. I certainly would not be. Just saying:)

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  2. I'd heard vaguely of this problem before, but the specific cases make the problem so much clearer. Given the high cost of homes in Toronto/Vancouver etc now, and the incredibly (to me) high rates of separation and divorce, this is really important information to get out there. I really hope, though, that it will never be directly relevant to my family (or yours!)....

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    1. Me too. Bet, I never even knew you have your own blog until last week. I guess I am oblivious or you make comments that are not self serving to your blog :)

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    2. That's ok, I believe only my Mom knows I blog. It's part of my self-imposed skills upgrading.

      I learn the most interesting things from your blog, even if the will/RESP one did set me back a little cash. But your sense of humour really keeps me coming back.

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    3. Thx Bet, you know us CA's are known for our sense of humour :)

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  3. What happens if you gift a lump sum amount to your child before marriage? Would he/she have to give up half of the gift on separation/divorce?

    Cheers..

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    1. Be*n, as a non-lawyer I cannot provide legal advice. But I think this link by a lawyer answers your question.

      http://millsandmills.ca/2010/09/the-matrimonial-home-in-net-family-property-calculations/

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  4. BBC - This topic hits close to home ... oops sorry for the pun. My company (incorporated) holds mortgages on both our kids homes and they are married and one happens to be a lawyer and that one who is a lawyer happens to be married to a lawyer ... yes having funds to help is great but we do have legal documents on file. Payments are made per the contract and the interest is realized by the company and it is satisfying to know we've taken The Banks out of the equation. After reading this post and other links I believe we have all bases covered BUT just because I feel all is well and good; if either marriage goes bad it could be messy.

    Nugget

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    1. Nugget, glad you got legal advice. Hopefully also tax advice in regard to mortgages to your kids from a corp as there are sometimes shareholder appropriation issues.

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    2. Shareholder appropriation issues ???
      Note: Kids are NOT shareholders of corp.
      Mortgage documents were properly executed by their respective lawyers. 3% rate of interest which is reasonable. Corp declares income from all interest and other sources. Been doing this for several years.
      Now realistically one day the kids will own their respective houses and it's doubtful we will die broke so they will get their money back too!
      Hopefully I continue to pass the CRA / RevCan sniff test.
      Nugget

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    3. Nugget,

      Unless you have been audited, you have not passed a smell test; u just have not been audited. It does not matter if kids are s/h. The wording in 15(2) is connected to the S/h. Just saying not so clear cut as you assume it is. Ask you accountant if he considers your kids connected or not?

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    4. BBC - thanks,I will ask and yes I have been audited albeit 20+ years ago ... it was a wake-up call I will admit. No penalties, a slap on the wrist and refile of the previous 5 or so years ... pay the corrected tax and move on. I'll take some blame but my so called accountant of that era wasn't doing their job!
      That's when I got a new accountant who coincidentally had worked for Rev Can. He got me smelling clean.
      Nugget

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  5. Great topic Mark. As always - relevant, practical and interesting.

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  6. I read -and reread- IT-119R4 today, and am still scratching my head.

    I am trying to understand if my 100% owned small business corporation can give me a loan or 'mortgage' to buy a house without any adverse tax effects?

    I understand there may be a taxable benefit from unpaid loan interest - but what I am really worried about is the entire loan amount being taxed as income in my hands.

    If I understand it right 15(2.4)(b) appears to say that as long as I am an employee of the corporation I have a green light here -- but it leaves me scratching my head as it appears to be a tax loophole that is too good to be true.

    What am I missing here?

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    1. Hi Anon

      You must speak to your accountant or hire one. This a bit of a minefield. The CRA may assess u a benefit for the entire loan if all your employees are not offered the same loan terms. This is not a green light, but an amber with huge tax consequences. Get advice.

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  7. ok. Thanks for your thoughts. I thought it sounded too easy.

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