Helping Your Kids With Home Equity Is Tax-Free. The Interest Is Not.
A cash gift to an adult child is one of the simpler transactions in Canadian tax law. Canada has no gift tax. A parent who gives a son or daughter $50,000 in cash toward a down payment in Charlottetown owes no tax on the transfer itself, and the child doesn't report the money as income. Gifts of property other than cash, such as shares or a cottage, can trigger capital gains for the parent, but a straight cash gift generally passes without tax on either side.
The cost usually shows up in where the money comes from. For many Island parents, the largest pool of available money is the house. The mortgage is paid off or nearly so, the RRSPs are set aside for retirement income, and a home equity line of credit or a reverse mortgage looks like the easiest way to turn that equity into a down payment. The gift still arrives tax-free. The parent, though, now carries a debt, and the interest on that debt generally isn't deductible, because the borrowed money paid for a personal gift. Under the Canada Revenue Agency's guidance in Income Tax Folio S3-F6-C1, interest is generally deductible only when the borrowed money is used for a qualifying income-earning purpose, such as earning investment or business income, and that use can be traced from the loan to the investment or business. There also has to be a legal obligation to pay the interest, the amount has to be reasonable, and the other CRA requirements have to be met. A gift to a child fails the first condition before the others come into play.
What the gift actually costs
A HELOC is the most common route. Most lines allow interest-only payments, which keeps the monthly cost manageable and is also why the balance tends to sit untouched for years. Consider a parent who draws $100,000 to help with a purchase and pays only the interest. At an assumed constant rate of 5%, used here purely to illustrate the arithmetic and not as a current rate, that works out to $5,000 a year, or about $417 a month. Over ten years the parent pays $50,000 in interest and still owes the full $100,000, before any fees and with no principal repaid. Real HELOC rates are variable, move with the lender's prime rate, and will differ from this example in both directions over a decade.
A reverse mortgage works differently. No regular payments are required, which is the appeal for retirees on a fixed income. As the Financial Consumer Agency of Canada explains, the interest is added to the loan balance instead of being paid, so the amount owed grows over time. The loan generally becomes payable when the home is sold, when the borrower moves out permanently, for example into long-term care, or when the borrower dies. Where a couple borrows jointly, repayment is generally tied to the last remaining borrower, so a surviving spouse can usually stay in the home after the first death, subject to the terms of the contract. Each lender's agreement sets out its own triggers and default conditions, such as keeping property taxes and home insurance current, and those terms are worth reading closely before signing. Because interest is charged on an ever-larger balance, the debt grows faster each year it remains outstanding. Reverse mortgage rates are typically higher than those on regular mortgages or HELOCs, there are fees for appraisal, legal work and setup, and terms and penalties vary from lender to lender.
The two products ask for different things. A HELOC asks for a payment every month, out of pension and investment income. A reverse mortgage asks for nothing now and takes its cost out of the home's value later, which means out of the money that would otherwise fund your next move or your estate.
What it does to your options later
The interest is the visible cost. The quieter one is what the borrowing takes off the table. Many Island retirees are counting on their home in ways they haven't written down. It may be the money for a smaller bungalow or condo in Charlottetown when stairs become a problem. It may be the fund for private home care or a move into assisted living in Charlottetown or Summerside. Once equity has gone to a child's purchase, it can't easily be called back, and the gift letter your child's lender requires confirms in writing that it was never meant to be repaid.
There are structural limits too. Federally regulated lenders cap the revolving HELOC portion at 65% of the home's value, and a readvanceable mortgage requires at least 20% equity to remain in the home. These thresholds, set under OSFI's Guideline B-20, govern how much you can borrow; the interest rate you pay is a separate matter, set by the lender and tied to prime. If you borrow heavily now, the room that remains for your own needs is smaller and harder to reach.
The principal residence exemption is worth remembering here. If your home qualifies, growth in its value can be sheltered from tax when you sell, though the exemption is subject to eligibility rules, including that you ordinarily lived in the home and designate it for the years in question. Borrowing against the house doesn't make that gain taxable. It reduces what you keep: the HELOC or reverse mortgage balance, along with any interest that has built up, is repaid from the sale proceeds first, so every dollar owed comes out of the money left for your next home or your estate.
When borrowing for this makes sense
None of this means you shouldn't help. It means the decision should be weighed against your other choices. Drawing from an RRSP or RRIF triggers tax once, at your marginal rate. Borrowing avoids that tax but charges interest every year the balance remains. Depending on your bracket and how long the debt will be outstanding, the one-time tax can turn out cheaper.
For parents who still hold non-registered investments, there's sometimes a better order of operations, though it comes with conditions. The same CRA rules sit behind the Smith Manoeuvre™: interest can be deductible when the borrowed money is used to earn investment or business income, the borrowing can be traced directly to that use, the interest is legally owed and the amount is reasonable. Money borrowed and handed to a child doesn't qualify. If you sell non-registered investments to fund the gift and then borrow to buy new income-producing investments, the new interest may be deductible, but the sequence doesn't qualify automatically. The borrowed funds need to go directly into investments acquired to earn income, such as dividends or interest, and the trail from loan to investment has to stay clean enough to show the CRA how the money was actually used. Selling may also trigger capital gains in the year of the sale. A tax professional should run the numbers and review the structure before any money moves, because done properly the same help can cost noticeably less after tax, and done loosely it can leave you with non-deductible interest and a capital gains bill.
There's also a value no spreadsheet captures. Seeing a son or daughter settled in their own home while you're here to enjoy it is a real return, and for many families it settles the matter. It's just worth deciding that with the interest, the downsizing plan and the care fund all in front of you, so the help you give now doesn't come out of the security you'll need later.
A cash gift to an adult child is one of the simpler transactions in Canadian tax law. Canada has no gift tax. A parent who gives a son or daughter $50,000 in cash toward a down payment in Charlottetown owes no tax on the transfer itself, and the child doesn't report the money as income. Gifts of property other than cash, such as shares or a cottage, can trigger capital gains for the parent, but a straight cash gift generally passes without tax on either side.
The cost usually shows up in where the money comes from. For many Island parents, the largest pool of available money is the house. The mortgage is paid off or nearly so, the RRSPs are set aside for retirement income, and a home equity line of credit or a reverse mortgage looks like the easiest way to turn that equity into a down payment. The gift still arrives tax-free. The parent, though, now carries a debt, and the interest on that debt generally isn't deductible, because the borrowed money paid for a personal gift. Under the Canada Revenue Agency's guidance in Income Tax Folio S3-F6-C1, interest is generally deductible only when the borrowed money is used for a qualifying income-earning purpose, such as earning investment or business income, and that use can be traced from the loan to the investment or business. There also has to be a legal obligation to pay the interest, the amount has to be reasonable, and the other CRA requirements have to be met. A gift to a child fails the first condition before the others come into play.
What the gift actually costs
A HELOC is the most common route. Most lines allow interest-only payments, which keeps the monthly cost manageable and is also why the balance tends to sit untouched for years. Consider a parent who draws $100,000 to help with a purchase and pays only the interest. At an assumed constant rate of 5%, used here purely to illustrate the arithmetic and not as a current rate, that works out to $5,000 a year, or about $417 a month. Over ten years the parent pays $50,000 in interest and still owes the full $100,000, before any fees and with no principal repaid. Real HELOC rates are variable, move with the lender's prime rate, and will differ from this example in both directions over a decade.
A reverse mortgage works differently. No regular payments are required, which is the appeal for retirees on a fixed income. As the Financial Consumer Agency of Canada explains, the interest is added to the loan balance instead of being paid, so the amount owed grows over time. The loan generally becomes payable when the home is sold, when the borrower moves out permanently, for example into long-term care, or when the borrower dies. Where a couple borrows jointly, repayment is generally tied to the last remaining borrower, so a surviving spouse can usually stay in the home after the first death, subject to the terms of the contract. Each lender's agreement sets out its own triggers and default conditions, such as keeping property taxes and home insurance current, and those terms are worth reading closely before signing. Because interest is charged on an ever-larger balance, the debt grows faster each year it remains outstanding. Reverse mortgage rates are typically higher than those on regular mortgages or HELOCs, there are fees for appraisal, legal work and setup, and terms and penalties vary from lender to lender.
The two products ask for different things. A HELOC asks for a payment every month, out of pension and investment income. A reverse mortgage asks for nothing now and takes its cost out of the home's value later, which means out of the money that would otherwise fund your next move or your estate.
What it does to your options later
The interest is the visible cost. The quieter one is what the borrowing takes off the table. Many Island retirees are counting on their home in ways they haven't written down. It may be the money for a smaller bungalow or condo in Charlottetown when stairs become a problem. It may be the fund for private home care or a move into assisted living in Charlottetown or Summerside. Once equity has gone to a child's purchase, it can't easily be called back, and the gift letter your child's lender requires confirms in writing that it was never meant to be repaid.
There are structural limits too. Federally regulated lenders cap the revolving HELOC portion at 65% of the home's value, and a readvanceable mortgage requires at least 20% equity to remain in the home. These thresholds, set under OSFI's Guideline B-20, govern how much you can borrow; the interest rate you pay is a separate matter, set by the lender and tied to prime. If you borrow heavily now, the room that remains for your own needs is smaller and harder to reach.
The principal residence exemption is worth remembering here. If your home qualifies, growth in its value can be sheltered from tax when you sell, though the exemption is subject to eligibility rules, including that you ordinarily lived in the home and designate it for the years in question. Borrowing against the house doesn't make that gain taxable. It reduces what you keep: the HELOC or reverse mortgage balance, along with any interest that has built up, is repaid from the sale proceeds first, so every dollar owed comes out of the money left for your next home or your estate.
When borrowing for this makes sense
None of this means you shouldn't help. It means the decision should be weighed against your other choices. Drawing from an RRSP or RRIF triggers tax once, at your marginal rate. Borrowing avoids that tax but charges interest every year the balance remains. Depending on your bracket and how long the debt will be outstanding, the one-time tax can turn out cheaper.
For parents who still hold non-registered investments, there's sometimes a better order of operations, though it comes with conditions. The same CRA rules sit behind the Smith Manoeuvre™: interest can be deductible when the borrowed money is used to earn investment or business income, the borrowing can be traced directly to that use, the interest is legally owed and the amount is reasonable. Money borrowed and handed to a child doesn't qualify. If you sell non-registered investments to fund the gift and then borrow to buy new income-producing investments, the new interest may be deductible, but the sequence doesn't qualify automatically. The borrowed funds need to go directly into investments acquired to earn income, such as dividends or interest, and the trail from loan to investment has to stay clean enough to show the CRA how the money was actually used. Selling may also trigger capital gains in the year of the sale. A tax professional should run the numbers and review the structure before any money moves, because done properly the same help can cost noticeably less after tax, and done loosely it can leave you with non-deductible interest and a capital gains bill.
There's also a value no spreadsheet captures. Seeing a son or daughter settled in their own home while you're here to enjoy it is a real return, and for many families it settles the matter. It's just worth deciding that with the interest, the downsizing plan and the care fund all in front of you, so the help you give now doesn't come out of the security you'll need later.
Sources
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