Excerpted with permission from The Bank of Mom and Dad: Money, Parents, and Grown Children by Derrick Penner, Published by Self-Counsel Press.
Co-ownership between parents and children is another route to help the younger generation own property, especially in North America's high priced markets, and cases where mom and dad might want to keep grandchildren close.
To the kids, it might feel like they are not escaping the co-living arrangement, but it allows mom and dad to share in the equity gains from rising property values. As the kids' need for more room to house a growing family increases, as the parents need for space decreases, the kids can arrange to slowly assume full ownership over time.
Parents and children don't have to live together in a co-ownership arrangement. Buying together as an investment might simply be a way to secure a mortgage for the kids. In that case, parents should not forget that this triggers a capital gains tax when the home is eventually sold. However, if parents are going into the purchase simply to help the kids qualify for the mortgage and intend their contribution to be a gift, they can structure ownership so that their interest is nominal, and work with a lawyer to place that interest in a trust for the benefit of the kids.
Parents might also have ways of leveraging the existing family home to give their children a place of their own that is close, but isn't the basement, or the childhood room that can barely contain their adult selves. Secondary suites go by many names (e.g., coach houses, granny flats, garden suites, or guesthouses), but small dwellings on the same property as a house are becoming increasingly accepted as a form of housing to help alleviate the affordability issues being experienced in many North American cities.
In Vancouver, they are referred to as laneway houses and have been ever widely adopted as a means for house-wealthy parents to give their kids a leg up in the country's most expensive property market. The cost to build a secondary dwelling can approach $300,000, and ownership of the additional unit cannot be subdivided from the initial home. Title for a laneway home remains with the principal home owner, but financial institutions are becoming more innovative in methods of financing a secondary unit that acknowledge the family dynamic involved in building them.
For a family that is close, it might be the preferred option of co-ownership, giving both parents and kids the comfort of financial security while also giving each side their own, distinctive and contained space; in other words, together, but separate. Once the financial arrangements are set and both sides have agreed about who is paying what to carry the expense of building a laneway home, it will give the kids more budget breathing room to build up their finances for full home ownership. Parents may have the option of trading places with their kids once they are ready to downsize and the kids are in the position of starting their own family (and have established more financial wherewithal to handle full home ownership). It can be beneficial to both parties, such as having grandparents close by to look after grandchildren, or kids nearby to help aging and ailing parents.
However, if parents are looking for a little more distance when they decide to reduce house size, the laneway house can still become an important factor in whether the kids are able to take over ownership of the whole property. A coach house, or laneway home, will add considerable value to a property, but the opportunity to rent it provides significant income that can factor into the calculation of whether the kids can afford to assume full ownership of the property. It won't necessarily be on a dollar-for-dollar basis, but many financial institutions will allow a high percentage of the rent a home owner is able to charge for a secondary unit as income to service a mortgage. If a secondary residence can be rented for $1,800 per month, for example, and the prospective buyer's bank allows them to count 90 per cent of that amount as income for a mortgage application, it has the potential of dramatically beefing up the potential of the buyer's mortgage application.
There are pitfalls. Owners can't look on the process casually as simply a little bit of help for their own mortgage. Renting the property is a business and needs to be treated as such. This means building financial cushions related specifically to the secondary dwelling, such as to covering gaps in income for periods when the unit isn't rented. There are additional insurance costs and emergency repair considerations such as when a washer overflows and floods the tenant's space. Owners also have to be ready for potential landlord-tenant disputes. Not all tenancies go smoothly, so landlords have to know the terms of whatever landlord-tenant laws govern their state or province, and how to use dispute-resolution tribunals under that legislation, in order to deal with those problems.
As with any transaction with the Bank of Mom and Dad, beyond any documentation that goes along with the mortgage, it is a good idea to enter into co-ownership with a solid agreement in writing about who will be responsible for what payments, and what happens in the event of unforeseen circumstances, or if living arrangements no longer work for one party of the other. It is better to have those details spelled out rather than disputing memories of who agreed to do what in verbal agreements when something goes wrong. When it comes to establishing a secondary dwelling, building such a unit is a substantial investment that can involve increasing the mortgage debt that will likely wind up being in the parents' name initially, so it isn't an arrangement that should be entered into lightly and not without an agreement in writing.
Chances are, the parents who are capable of contemplating an arrangement to help their kid purchase a home have been on the receiving end of an inheritance themselves. Considering the amount that property values have risen in some of North America's pricier markets, such as Vancouver, San Francisco, Toronto, and New York, the death of their own parents, and sale of a family home may leave people with more freedom to be generous.
In the rare case parents might be able to buy a home for their child outright. Such generosity does come with a catch. If the parents do the buying and transfer ownership to their child, they need to be aware of the potential to trigger a tax on capital gains. In Canada, for tax purposes, Canada Revenue Agency will consider the transfer of property to have occurred at a fair market value, and any increase in that value between the purchase and handing over ownership to a child will be taxable regardless of whether the parents expect any repayment.