How much interest must I pay the Bank of Mum and Dad?
Q&A: Dominic Coyle
Misunderstandings and disputes over assets, gifts, inheritances and perceived preferential treatment have the capacity to tear families asunder.
My parents have recently agreed to purchase a nearby house as an investment property. The sale has not closed yet (a 10 per cent deposit has been paid already). They are considering future tax planning and have proposed that the property purchase be completed in my name.
The purchase price is €100,000, with significant renovations required which would be expected to increase the value of the property substantially.
We are considering ways that this can be achieved to avoid using up the Category A CAT relief available as there other assets I am likely to inherit in the future which would use up this limit.
One option that looks possible is that, instead of my parents purchasing this house themselves, that they simply loan me the entire purchase price to complete the purchase, which I would then be able to repay from any rental proceeds the house might make in the future.
Are there any reasons this is not possible as it seems very straightforward? We would be proposing to set an agreed interest rate which I would pay, though without an agreed repayment timeline. Is there any guidance on setting acceptable interest rates on these loans from Revenue?
I own my own home, and the house in question would be used solely as a rental property.
Mr N.O’B., email
It’s one thing having informal arrangements within a family but when it comes to the law, clarity and certainty are critical – not least because anything else could lead to inadvertent liabilities.
In this case, as I see it, the understanding is that this €100,000 property will, after upgrading, be worth considerably more. For that reason, and given that it is likely to pass to you at some point, your parents are looking to plan their affairs in such a way as to minimise your exposure to tax – and theirs.
That’s fair enough as far as it goes.
Where it gets complicated is when you get to legal title. You say the purchase of this property has not yet closed but is expected to do so shortly. It appears to be a cash transaction as so many are these days, so at least there is no complication with whose name is on the mortgage and who does or does not have to stand guarantor.
But whose name is on the contract of purchase and in whose name will the deeds of title be?
This matters because if it is your parents, then they own the house and any subsequent transfer to you would depend on the value of the property at that time.
I suspect if a deposit has already been paid by them, the presumption of the seller’s legal advisers is that the contracts are being made out in your parents’ names. On the understanding that they wish you now to own the house, you will need to have this changed so that it is your name that appears on the title.
This, of course, is a leap of faith because, once you are formally recognised as owner, they can rely only on your good faith to repay the money involved. But again, as I understand it, that is not so much the issue: it is more that they want you to have the property in the most tax-efficient manner.
So that brings us to the loan. How must that be treated?
The important thing is the Revenue does not impose a specific rate of interest. They have confirmed that to me.
However, market interest must be paid. Revenue says that the value of the loan is determined in tax law as “the best price obtainable in the open market” for the use of the loaned money. In simple terms, that means you are entitled to take the most advantageous interest rate at the end of each year as the rate you owe in interest on the loan, or what is left outstanding on it, at that point.
As you state, there is no repayment period set down, so it is simply a case of applying the market best rate on the outstanding capital at the end of each year. The best rate can obviously change from year to year as can the identity of the institution offering it.
From your perspective, all that matters is the best rate, not whom is offering it.
If you pay less in interest than the market rate in a given year, that undershoot will be treated as a taxable gift to you from your parents. Of course, it is possible to use the annual small-gift exemption of €3,000 (from each parent) to reduce how much interest you must physically pay each year.
By the way, your loan will have to include the 10 per cent deposit already paid or that will be considered a gift, reducing your lifetime limit which, as I understand it, you want to retain to reduce your tax liability whenever they ultimately die and the estate passes to you.
You mention that you already have a home so this will be considered an investment property.
That means that:
a) if and when you eventually go to sell it, it will be liable for capital gains. And as the enhancements to significantly increase its value happen on your watch (ie ownership), that liability will fall on you. If your parents owned the property when they died, capital gains would die with them but, of course, the value of the property at that time would be considered in assessing your liability to capital acquisitions tax;
b) you will also be liable for income tax, USC, etc on any net rental income earned from letting out the property, as it is in your name.
That sorts you out, but what about your parents?
Well, in the same way that you must abide by tax law and pay a market rate or have the sum set against your lifetime limits (outside of the small-gift exemption), so too the interest that your parents receive will be considered income for them and go towards their annual income when they are assessing income tax and other liabilities.
Finally, you don’t say but I assume there are no other siblings here. It is not that they would negate the position outlined above but the capacity for misunderstandings and disputes over assets, gifts, inheritances and perceived preferential treatment has the capacity to tear families asunder.
Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2, or email email@example.com. This column is a reader service and is not intended to replace professional advice