Understanding the tax implications of co-signing a child’s mortgage
One of the most common ways a parent can help out a child is to either gift or loan them money to assist them in financing their first home. Alternatively, parents who either can’t afford to make a gift or loan, or perhaps simply don’t want to, may still be in a position to do the next best thing — guarantee the mortgage on their kid’s home.
The Canada Revenue Agency recently responded to a taxpayer inquiry involving such a loan guarantee. In the case in question, two taxpayers we will call Jack and Diane were getting a divorce and Diane wanted to buy her own home. Her parents co-signed for the mortgage so she could purchase the new home since she already owned an existing home with Jack that they were trying to sell.
Diane’s parents neither lived in the new home nor contributed any money toward the purchase of the home, nor did they pay for any of the utilities, property taxes or repairs. Diane and her parents also signed a document stating that the parents “have no financial interest in the home.” Notwithstanding all this, however, Diane’s parents hold legal title to the new home since they were required to co-sign for the mortgage.
Diane’s parents also own their own home in another city, which they have lived in for many years. Diane and her parents would like to leave their names on the title of the new home since they want to avoid paying land transfer tax to have their names removed from the property.
Diane wrote to the CRA because she wanted assurance that if she later sold the home at a profit, that gain could be sheltered by her principal residence exemption and wouldn’t be subject to capital gains tax in her parents’ hands despite her parents being on title as legal owners.
The CRA responded that according to the definition of “principal residence” in the Income Tax Act, “the property must be owned by the taxpayer at any time in the year” to qualify as a principal residence.
The Tax Act, however, doesn’t define the word “owned” so we are left with the two most common forms of ownership – legal and beneficial. In most cases, the legal owner will also be the beneficial owner. However, it is certainly possible for someone to have legal title to something, in that title is registered in their name, yet have someone else be entitled to the use and benefit of the property, known as “beneficial ownership.”
The CRA concluded that if it is truly Diane and her parents’ intention that Diane be the sole beneficial owner of the home and that her parents merely hold legal title because they were required to do so as guarantors of the mortgage, Diane, as the beneficial owner, and not her parents, would be responsible for reporting any future capital gain at the time the home is sold. This means that presumably Diane could use her principal residence exemption to avoid paying tax on any future gain at the time of sale.