Before gifting a house deposit, consider an asset protection strategy
Parents helping their children into the property market often focus on the deposit, but documenting the advance as a formal loan rather than a gift may provide greater long-term asset protection if circumstances change.
One of the most rewarding things parents can do is help their children enter the property market.
For some families, that assistance comes in the form of a home deposit or contribution towards the purchase price.
What many parents do not realise is that how the funds are advanced can have significant long-term consequences.
In our tax planning work, we regularly recommend that families consider establishing a formal discretionary loan agreement rather than making an outright cash gift. The difference may not seem important today, but years later it can materially affect the family’s financial position.
A gift and a loan are not the same
A discretionary loan agreement is a formal legal agreement documenting that the funds are a loan, not a gift. Typically, the agreement provides that:
- the funds are repayable on demand
- an interest rate is specified, usually on commercial terms
- the lender retains discretion over when, or if, the loan is called upon.
The objective is to preserve the legal identity of the funds and that distinction can become extremely important if circumstances change.
Why this financial plan matters?
None of us want our children to experience a relationship breakdown. Unfortunately, they do occur.
Where parents have simply gifted a home deposit, those funds may become part of the couple’s overall asset pool. In practical terms, the parents’ contribution may ultimately be shared with a former partner.
Where the funds have been properly documented as a loan, they may instead be recognised as a liability that needs to be considered before the remaining equity is divided. Documenting the arrangement from the outset generally provides a much stronger position than relying on verbal understandings years later.
A practical example
Assume the following:
- Parents advance $250,000 to their adult child and the child purchases a $1,000,000 property.
- A discretionary loan agreement documents the advance.
- The loan carries interest at 7 per cent per annum, compounded annually.
- Five years later the property is sold for $1,500,000 following a relationship breakdown.
The property has increased in value by $500,000.
After five years, the original $250,000 loan has grown to approximately $350,000 under the terms of the agreement compounding each year by 7 per cent.
Rather than treating the original parental contribution as a gift, the documented loan remains a liability that is considered before the remaining equity is available for division.
The financial outcome can be materially different.
Not about expecting the worst
Some parents worry that putting a loan agreement in place sends the wrong message.
In reality, it is no different from preparing a will or arranging appropriate insurance. Nobody expects things to go wrong, but prudent planning recognises that circumstances can change.
A discretionary loan agreement allows parents to:
- help their children purchase a home
- preserve the family’s capital
- retain flexibility over repayment
- better protect family wealth if circumstances change
- potentially assist their children again in the future if needed.
The key is getting the structure right before the money changes hands, as once funds have been transferred as an informal gift, it can be difficult to recreate the intended arrangement later.
Like most tax and asset protection strategies, planning before the event is almost always more effective than trying to unwind decisions afterwards.
Helping your children into the property market is often one of the most generous financial decisions you will ever make.
Taking the time to structure that assistance correctly can help ensure your generosity benefits your family in the way you intended.
