I’m in the process of loaning money to my daughter, to build a house in a new development area in White River. How can I protect myself in the matter? There has to be a written agreement on the interest that they’ll pay me monthly. They’ll pay back capital, but if they decided to sell the house, the capital that I put in has to come back to me. I want to stipulate that in a contract.
What’s the tax impact to me? I want to make it clear that it’s not a donation but a loan. What if the sudden drop in investment capital prompted such a question from Sars (donation vs loan)?
At the outset it should be put forward that I am not a legal or tax expert but hopefully have sufficient understanding of the dynamics at hand to give you some guidance. Please note the information provided below does not constitute financial advice. Generic information has been applied in the context of your question. We have very limited detail about you and your circumstances; such detail may impact any advice provided.
After asking around it appears that there is no obligation for you to charge interest on a ‘family loan’, but it is certainly reasonable as you are losing out on a return that would have been earned on the cash if it remained in your hands. Any interest received by you would be taxable in your hands.
The loan agreement itself should provide validity to the arrangement and it should not be viewed as a donation, whether or not interest is being paid, as a valid agreement is in place. I will also give you some other ideas, detailed below, that could add robustness to the arrangement.
Here are a few points to consider when drafting the loan agreement as well as some other related thoughts:
- The loan agreement should set out the repayment period, repayment frequency as well as the repayment terms. You have already considered interest as well as the position if your daughter sells the property – both are valid concerns. With regards to interest, the agreement must stipulate the rate of interest to be applied. You could, for example, set this as percentage of the the prime-rate.
- You need to consider if the loan is going to be secured versus unsecured. The difficulty may come in if there is a default. You could look at taking cession over the asset, if the agreement sets the property out as security for the loan – but the practical enforcement to this, given that it regards a close family member, may be difficult.
- There could also be an unfortunate situation where your daughter is unable to pay the loan due to ill health or death in which case you could include a guarantor, perhaps her husband, into the arrangement.
- Your last will and testament should include the loan (asset in your estate), adding credence to the loan agreement, as well as provisions relating to the recoverability thereof.
- You could bequeath the loan to your spouse if you are the first to die, in which case you need to include provision for what happens when he/she dies.
- You could bequeath the loan back to your daughter and the loan amount could be offset against other inheritances so the other beneficiaries aren’t prejudiced.
- A nice idea may be taking out a life policy where your daughter is the owner, you are the life assured and she is the premium payer. On your death the policy would pay out to her and provide the funds to repay the loan. There are a few variations to the way this could be structured.
We would suggest engaging with an attorney who has the necessary skill and experience to draft the agreement, taking into account your specific needs, while alerting you to the various available options as well as the pitfalls.