Australia is gripped in a well-publicised housing crisis, which disproportionately impacts first home buyers. As a consequence, families with the ability to assist are increasingly exploring options to support their children to enter the property market.
Several strategies exist to achieve this, each with their own advantages and disadvantages. Selecting a strategy requires a balancing of competing considerations, including asset and family wealth protection, potential tax implications, and other personal circumstances.
We have outlined below some of the strategies used by our clients, and key considerations for each.
Acting as a guarantor
Previously, one of the most common ways that parents assisted their children to buy property was by providing a guarantee to support their children’s bank loans. This was often (and still is) considered in circumstances where a parent has equity in property of their own, but has limited available cash. While this strategy is still utilised in the current market, we are seeing less appetite for, and additional restrictions imposed by banks when accepting, this type of security to support otherwise uncertain loans. While this strategy can reduce the Lenders Mortgage Insurance (LMI) payable by the child, this strategy carries risk for the parents. Specifically, if the child defaults on their mortgage, the parents may be held personally liable for the debt. This may also impact the credit rating and borrowing capacity of parents for future loans, as a bank will often not permit release of a guarantee without the loan being repaid (or paid down), or replacement security being provided.
Gift of money
Another common way that parents assist their children to purchase property is to provide a gift of money, with no expectation of repayment. In such circumstances, a bank will often require a declaration from the parents confirming the money provided was a gift and not a loan.
Care should be taken where either the parents or child receive a pension or other similar support, as the making or receiving of a gift could impact eligibility. There are also significant risks from a family law perspective which means that it is imperative that the child who receives the gift obtain specialist family law advice.
There is a general presumption that payments from parents to children are a gift. If there is an expectation that the money is repaid (for example, upon sale of the property), then this arrangement needs to be properly documented as a loan.
For more information about this, please see the quick considerations section below.
Loan
Increasingly, parents are stepping in and providing private loans to help their children purchase property. This strategy not only supports home ownership but also assists to safeguard family wealth in the event of family disputes or marital breakdown, noting family courts typically require all loans to be repaid before dividing the family assets.
To rebut the presumption of a gift, this arrangement must be properly documented as a loan. Parents should also give serious consideration to taking a registered mortgage (not an unregistered mortgage or caveat) so secure the loan, so as to rank in priority to other creditors of their child.
For more information about this, please see the quick considerations section below.
Co-purchasing property
Parents may choose to co-purchase property with their child. While this can increase the borrowing capacity of their child, such arrangements can be complex and carry potential tax consequences. These arrangements can also expose the parent’s interest to family law or bankruptcy proceedings affecting the child (or vice versa).
It is essential to determine how ownership will be structured – in an entity such as a trust, or as joint tenants or tenants in common – and to understand the estate planning and tax consequences of that structure (e.g. the impact on availability of potential first home concessions, and capital gains tax implications for the parents).
The ongoing obligations in relation to the property (e.g. responsibility for ongoing costs, repairs and maintenance etc.) should also be considered and documented in a co-ownership agreement. We also regularly see rights of refusal and ‘drag along’ rights included, ensuring that parties have a mechanism of effectively ending the arrangement in the future if needed.
Where a child is borrowing from a bank to fund their share, co-ownership may result in parents having to guarantee that loan, and parents may also still provide additional funds either by way of a gift or a loan. This can be dealt with in a co-ownership agreement.
Bare trustee
In some circumstances, parents buy property for their child with the intention that the child pays all costs and that there is an understanding that the parents hold the property for the child’s benefit. This may be done, for example, because the child is finding it difficult to obtaining finance to acquire the property.
This arrangement may be a form of trust known as a bare trust which ordinarily refers to an arrangement where a trustee holds property on behalf of the beneficial owners of the property, with minimal duties other than to transfer the trust property upon direction to the beneficiaries.
When setting up this arrangement:
- a formal bare trust deed should be prepared to outline how and when the property will be transferred to the child upon their request, or once all repayments have been met;
- it is important to clarify who is responsible for any property payments which are incurred in the normal course of owning a property (i.e. rates, land tax);
- consideration should be given to any potential capital gains tax exemptions and any duty or land tax implications; and
- if the child will live in the property, a formal lease should be put in place.
From time to time, we are asked to review informal structures that contain some or all of the above arrangements. Often families seek to unwind such arrangements and are concerned that there will be capital gains tax costs and stamp duty to do so.
These arrangements are often difficult to unwind without very significant tax costs, and families considering such arrangements should obtain specialist advice before entering into them.
Quick considerations – is it a loan or a gift?
Courts typically consider the following factors when deciding if an arrangement is a loan or a gift:
- Is there a written loan agreement?
- Have the terms of the loan agreement been complied with by both parties?
- Has the child made any repayments?
- Did the parents take security, such as a mortgage over the property?
- Was there otherwise a clear expectation that the funds would be repaid at some stage?
Quick considerations – loan documentation
When preparing loan documents, parents should consider the following:
- Will they borrow from a separate lender and then lend that money to their child, or lend money from their personal wealth?
- Will the loan be made personally, or through a company or trust? There can be tax implications for each, including potentially treating the loan as a deemed, unfranked dividend under Division 7A issues. The parties should consider such issues very carefully and obtain specialist tax advice.
- Will the child provide security (such as a mortgage over the property)?
- When will the loan be due? This can be tailored (e.g. on a fixed date or on sale of the property) and can be on demand, though care should be taken to ensure that any limitation of actions periods are addressed to avoid the loan becoming unenforceable.
- Will interest be payable on the loan? If so, will the interest rate be fixed or variable and when will interest accrue? This can significantly impact on parents’ income tax liabilities.
- What periodic repayments (if any) are to be made by the child, including amount and frequency?
Estate planning
Each of these strategies will have an impact on estate planning arrangements, so it is crucial when drafting estate planning documents (including wills), to clarify:
- whether payments that have been made were gifts or loans, as this is a common area of dispute between children in the administration of an estate;
- where there has been a gift, whether there should be an equalising gift to any other children;
- for any loans, the terms and details (including amount) of the loan, whether the loan is payable to the estate on death or forgiven, and how the loan impacts any inheritance specified in the will (including any division of assets amongst other beneficiaries);
- whether there are any other estate planning strategies available to deal with the loan which might maximise asset protection opportunities; and
- for co-ownership, whether the property should be specifically gifted to that child or appropriated to them as part of their interest in the estate (rather than dealt with as part of the estate more generally, which could result in complex ownership arrangements).
If your estate is at risk to litigation, it is important to seek advice about how documented loans or a history of providing financial support might impact the success or otherwise of a claim.
Key takeaways
Helping children to enter the property market can be rewarding but it comes with complexities and may spark difficult conversations. Done incorrectly there is an enormous risk of adverse tax and asset protection consequences.
It is important to consider the various tax, financial, asset protection and estate planning consequences of each of the strategies outlined above, and to seek independent legal and tax advice in respect of any arrangements.
McR Private can help you to understand the impacts of each arrangement and prepare formal documentation tailored to your family’s needs, ensuring your interests are protected and the arrangement appropriately deals with financial, tax and estate planning considerations.
McR Private Fast Five event: Family Lending
Join us in our Brisbane office on Wednesday, 6 November, for our latest “Fast Five” seminar covering the five key issues that families and advisers should consider when assisting children to enter the property market. This will be followed by an opportunity to continue the discussion with the McR Private team over refreshments.
Presenters:
- David Hughes, Partner, Tax
- Emile McPhee, Special Counsel, Real Estate and Finance
- Paige Edwards, Special Counsel, Estates
- Alex McCowan, Senior Associate, Estates; and
- welcoming Kate Alroe, special guest and Senior Associate from Lander & Rogers Family and Relationship Law team.