Mark emailed me with an interesting scenario in building a house for his parents and renting it out to them.  It’s not that his parents can’t afford to build their own, Mike is simply wondering about the benefits and pitfalls of such an arrangement.  Here are more details:

My parents are thinking of selling their home and building a new one. They are both in they’re mid 60s and would live in the new house for the next 15+ years. I’m trying to crunch the numbers to see if it makes sense for me to build it for them and rent to them. They would lend me the money from the sale of thier home at whatever interest rate makes the most sense for this plan. I could potentially lose money on the house every year (rent coming up short of the costs) and take a tax write down. At  anytime in the future I could sell them the house at cost so as to not incur capital gains. There is more to it but I’m just getting started. Have you ever thought out a senario like this?

  • The current house would sell for about $235k with $180k of that being free and clear.
  • The new build is estimated at $215k.
  • Market rent would be about $1200-$1300. $1500 would not be out of the question for a brand new place.
  • I can get money from our banker at prime.
  • The rate my parents would charge would be whatever is best for both of us.

The purpose of this would be to try and set up a mutually beneficial situation where we both are better off. The keys would be tax efficiency and cash flow (might be others I have not figured out yet).

There a few key points to think about, that is monthly cash flow, inheritance, and overall cost to the parents.

Let go through each scenario.

Parents Build Themselves

If the parents build a $215k home, they would be left with a $35k mortgage providing they use the equity from the old home (assume no realtor fees).  With today’s 5 year rates being around 4.19%, the payments would be about $189/mo over 25 years or $262/month over 15 years.  Depending on the financial situation of the parents, paying $262/month +tax/insurance/maintenance is much less than market rent.

Mark Builds and Rents House to his Parents

If Mark were to build the house for $215k and borrow $180k from his parents, he would be left with $35k to either borrow from the bank or cover himself providing he has the cash.   Assuming the same rates as above, the bank payments would be the same.  That is $189/mo over 25 years or $262/month over 15 years.  However, he needs to account for paying back his parents as well.  If his parents were extremely generous and offered the $180k interest free with monthly principal payments only, it would be $600/month over 25 years or $1,000/month over 15 years.  Assuming that market rent is $1,300/month, the property would be barely cash flow positive over  a 15 year amortization (my number one rule).  If Mark is determined to make this work, he would need to contribute a large down payment.


An alternative idea not discussed is simply putting Mark on title.  Although this would sound like an ideal scenario, it can get a little complicated as there are tax and legal implications.  More on this topic on another day as it deserves a dedicated post.

Final Thoughts

I believe the primary benefit of this arrangement is that Mark would own the house without having to worry about probate fees when his parents pass away (there is no other tax when gifting a principal residence upon death).  However, there are many drawbacks.  First, the parents would have to pay much more in rent than owning themselves.  In addition, even if the parents paid market rent, the investment property is not cash flow positive after taking into account property maintenance, taxes and insurance.

In my opinion,  it might be best to simply let the parents build their own house and gift the house to the chlid after passing (via a will).  They may face a relatively small probate fee, but no other taxes would be owed *.

* Note that capital gains tax would be payable on the property sale if the house is sold later at a value greater than the value assigned on the date of passing.

Disclaimer:  I’m not a financial advisor, anything written in this post should be used for informational purposes only.

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FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Ms Save Money
14 years ago

@ Chain link – In asian cultures – it’s actually rude to be charging your parents rent. When you’re grown you’re expected to take care of them.

14 years ago

Another thing to consider is the Principal Residence Exemption for those of us living in Canada. If the son were to own the home and own another home he would be required to pay Capital Gains on one of the two properties.

It would then be best for the parents to own the home as they would be able to take advantage of the exemption.

As for probate, it is possible to put the son on title without him being a beneficial owner until the passing of the parents however it would need specialized advice from both a tax lawyer and an accountant on how to set this up properly as CRA likes to look at these type of arrangements with a microscope. They will try to assess capital gains on his portion of ownership upon the parents death…

chain link
14 years ago

I would totally rent a house to my parents. At a discount of course.

Ms Save Money
14 years ago

@ Laptop Briefcases: I totally agree. It’s really hard to draw the line when they’re your family. Tough situation.

14 years ago

In my opinion, it is always the best to maintain as many primary residences within a family as possible. Capital gains don’t exist on primary residences, so it doesn’t make much sense in loaning money to child to then move in to the residence causing any gains in the property to now be taxed. Also, never put a child on title unless you know you are going to die before there are any substantial gains on the property. If one of the title holders dies, the property is deemed sold by the other party for tax purposes which can cause considerable tax consequences. I just went through this, so not a particularly wise tax strategy. Why not utilize the tax shelter while you can? As to probate fees, if you structure your life (family) properly and eliminate any debts before dying, it isn’t necessary to put the estate in probate. Alas, in the real world it seems that siblings tend to fight over everything.

Laptop Briefcases
14 years ago

Very interesting scenario. While it may work out financially, someone would have to settle for higher payments or lack of interest. It would be tough to work out a deal that really makes sense for both of you. It is a little tricky dealing with something like this with family. They may want to give you a great deal, but you may feel guilty about not paying interest or something like that.

14 years ago

Sarlock’s idea of having Mark replace his own mortgage with a mortgage on the new home has some merit (and of course many of the downsides mentioned in these comments). But you have to be very careful with the CRA. The interest on the mortgage is only tax-deductible if the investment has an expectation of profit. That means he would have to set the rent payments high enough that it fully covers all his expected costs. There is no way to rent it at a loss and still be able to make any tax deductions. This strategy might save Mark some money, but the high rent payments would cost his parents. I doubt he can “gift” some of the rent money back – the CRA would probably call that tax evasion.

14 years ago

The probate fee would likely be much lower than capital gains tax payable on a house held for 15 years. In Ontario, the probate fee is $15 per $1000 (less the mortgage if applicable). If the house were to double in value, the probate fee would be about $9,000. Capital gains tax payable at the lowest rate (say 17%) would be about $25,000 (and it wouldn’t likely be at the lowest rate if Mark has a job and rental income to add to the capital gains). If Mark owns the house, he will have to pay tax on the capital gain from initial cost to the date of sale. If the house is owned by his parents, it will be protected from capital gains tax by their principal residence exemption until sold or their death. If the house is held jointly with Mark, Mark would have to report his share of any capital gain from the date it went into his name to the date of the joint owners’ death or sale, while his parents’ share of the gain would be protected. If his parents own the house and then sell it and deposit the funds into a bank account held jointly with Mark, they would avoid both capital gains tax and probate fees as the balance in the bank account would pass to Mark on death not subject to probate fees. Also, as pointed out, if in Mark’s name, the house would be subject to claims by Mark’s creditors, including a spouse or dependents. Mark and his parents should get professional advice before moving ahead.

14 years ago

I agree with the other comments, to me it doesn’t seem like it’s worth the trouble, I don’t see the upside. Additionally, I would take issue with this statement: “At anytime in the future I could sell them the house at cost so as to not incur capital gains.”

My understanding is that selling the house to a family member would not be an arm’s length transaction, and thus you would need to prove to CRA (if they questioned you) that the house was sold at fair market value. It would be nice if you could just decide to sell the house at cost (or any figure you decide upon) to avoid capital gains, but I don’t believe this is possible. Those guys at CRA are pretty crafty. Every time a thought like this occurs to me to avoid taxes I check the tax code and they’ve got it covered…

14 years ago

I whole heartedly agree with abc. Don’t even think of doing this. I know my wife, if approached by any of our children during our retirement with this, would refuse this strongly and immediately.

You work so hard to own your home, and the emotional security that accrues with it, the last thing you want to be is a tenant. What is the upside for the parents? What is the upside for the son? What are the risks to either if circumstances change (one parent is no longer to take care of themself or dies, the son wants to start a family and buy his own home but can’t because of the capital tied up in the parent’s home)?

If you want to avoid probate fees and capital gains taxes, take out a life insurance policy on the parents and YOU pay the premiums. You will be the one who benefits so you should pay for it.

My mom proposed a similar idea to me – I would buy a condo and she would live in it. I only had to look at it as though it wasn’t my mother to realise that, for me, it wasn’t a good deal at all. When I factored in her poor health and the real possibility she would either not want to, or not be able to, live in it within just a few years of the arrangement and it was clear there was a lot of risk financially and emotionally.