What is the tax impact of a loan to my daughter?
I want to lend my daughter money to build a property, with a contract in place on how interest and principal will be repaid.
By Stephen Katzenellenbogen
April 30, 2018 00:10
I am lending my daughter money to build a house in a new development area in White River. How can I protect myself in this regard? There must be a written agreement on the interest they will pay me monthly. They pay back the capital, but if they decide to sell the house, the capital I invested must come back to me. I want to stipulate this in a contract.
What is the tax impact for me? I want to clarify that this is not a donation but a loan. What if the sudden drop in investment capital raised such questions from Sars (donation vs. loan)?
At the outset, it should be made clear that I am not a legal or tax expert, but hopefully I have enough understanding of the dynamics at hand to give you some advice. Please note that the information provided below does not constitute financial advice. Generic information has been applied in the context of your question. We have very few details about you and your situation; these details may affect the advice provided.
After asking around it appears you don’t have to charge interest on a “family loan”, but that’s certainly reasonable as you lose a return that would have been earned on the money if it was remained in your hands. Any interest received by you would be taxable in your hands.
The loan agreement itself should guarantee the validity of the arrangement and it should not be considered a gift whether or not interest is paid because a valid agreement is in place. I’ll also give you a few other ideas, detailed below, that might add some robustness to the arrangement.
Here are some things to consider when drafting the loan agreement along with some other related thoughts:
- The loan agreement should define the repayment period, the repayment frequency as well as the repayment terms. You’ve already considered the interest as well as the position if your daughter sells the property – both are valid concerns. In terms of interest, the agreement must stipulate the interest rate to be applied. You can, for example, set this as a percentage of the prime rate.
- You need to determine if the loan will be secured or unsecured. The difficulty can come if there is a defect. You might consider taking assignment of the asset, if the agreement defines the property as collateral for the loan – but the practical application of this, given that it is a close family member, may be difficult.
- There could also be an unfortunate situation where your daughter is unable to repay the loan due to poor health or death, in which case you could include a guarantor, possibly her husband, in the arrangement.
- Your last will must include the loan (property in your estate), adding debt to the loan contract, as well as the provisions relating to the collectibility of it.
- You can bequeath the loan to your spouse if you are the first to die, in which case you need to plan what will happen when they die.
- You could bequeath the loan to your daughter and the loan amount could be deducted from other inheritances so that other beneficiaries are not harmed.
- A good idea may be to take out a life insurance policy where your daughter is the owner, you are the life insured and she is the premium payer. When you die, the police would pay him money and provide him with the funds to repay the loan. There are a few variations in how this could be structured.
We suggest that you contact a lawyer who has the skills and experience to draft the agreement with your specific needs in mind, while alerting you to the various options available as well as the pitfalls.