It is easy not to think twice when you want to help out your children. But when it comes to loaning them money, parents should take into consideration what could happen if the arrangement goes sour.
It is natural for parents to want to support their children, even after they have up and left the nest to start their own life. Quite often, that support can involve providing financial assistance in the form of a loan.
Many young adults seek financial help from their parents if they encounter difficulty securing enough money for a down payment on a new home, a business venture or some other major expense.
In many cases, parents are more than willing to help give their children a financial boost, and in most scenarios, these parent-child loans can go quite smoothly. However, loans that are not paid back as agreed by both parties can cause great anguish for a family, and result in relationship breakdowns.
Since quite a few tax traps and legal pitfalls can arise when a loan agreement doesn’t work out, parents should carefully consider the implications of lending money to their children before doing so.
Proper documentation of a loan can avoid many complications. For example, if the child receiving the loan was to divorce from their partner, a written document identifying who handles the repayments can prevent the former partner from refusing to share the responsibility of the repayment.
For tax purposes, parents should also include a repayment schedule, repayment records and a plan that determines how the loan will be repaid as scheduled. If applicable, parents should also include proof that the child was credit-worthy when the loan was originally made.
Lending money to your children may have certain tax consequences for you as a parent, so it is also important to weigh up the likelihood of your child’s follow-through. Parents need to think carefully before lending money for a risky venture unless they are prepared to part with it as a gift with possible tax consequences. It may also be beneficial for parents to consider seeking professional or legal advice when before committing to the loan.