Our Federal government’s tax policy has for decades encouraged Canadians to strive for home ownership. As long as the home is our “Principal Residence”, any capital gain we achieve on it over the years is not taxed. This accounts for a huge proportion of the wealth and retirement savings of today’s elder and Boomer generations. The American system does it a bit differently – their capital gain is taxed, but each year of ownership, they can expense their mortgage interest payments to reduce their taxable income.
Value of a Principal Residence
A startling reality of the way Canada encourages home ownership is that there is no limit to the number of Principal Residences a family can collectively own – just that each family member can only have one.
A family with 3 kids could own a total of 4 homes, all seeing rising values, and gaining equity that won’t be taxed. If the ‘Bank of Mom and Dad’ can swing it, they could borrow against their own housing equity for funds to lend their kids, who could each then acquire a Principal Residence, and start building their own non-taxable equity.
This is the family wealth building strategy we had in mind when we designed the Live to Own™ program for affordable home ownership.
The combined impacts of financial leverage, rising asset values, and no income tax are powerful, and make this strategy compelling. We wish that every Canadian family could take advantage of this.
Let’s look at a hypothetical example, that makes use of the Live to Own™ program:
1975 – Mom and Dad bought their home, for, say, $100,000 – with a $25,000 down payment.
2021 – their house is now worth $2,000,000, the mortgage is paid off, and their gain is non-taxable.
2022 – they extract $40,000 of equity (with a “HELOC” – Home Equity Line of Credit) and lend it to their daughter Jen, as her Deposit Loan™ in the Live to Own™ program. After renting in the program for 5 years, she buys a home in 2027 for $400,000 with the $80,000 in equity the Deposit Loan™ grew to, which Mom and Dad decided they could gift to her.
2024 – Mom and Dad extract another $100,000 to provide for $50,000 Deposit Loans™ for each of their 2 sons, Eugene and Sam. They both start in the Live to Own™ program as renters, and in 5 years they each have $100,000 equity credit in the home of their choice. So they each buy their home at its option price of $500,000, with the $100,000 they had in equity grown in the program, during their renting years. (Mom and Dad also decide to gift the Deposit Loans™ to the boys, as their “advance inheritances”).
Potential Benefits of the Principal Residence
Let’s imagine that housing values have kept rising at an average of 4% each year. Here’s the family’s combined housing wealth, after another 10 years pass with their collective ownership of 4 homes:
It’s 2034:
Mom and Dad – Their home is now worth $3,330,000 But they borrowed $140,000 to help the kids, so their equity now is (We’ll imagine they paid the interest on their HELOC along the way):
$3,190,000
Jen – bought in 2027. Her home is now worth $526,000, but she still owes about $252,000 on her mortgage (that started out at $320,000) so her home equity is:
$274,000
Eugene – bought in 2029. His home is now worth $608,000, but he still owes about $272,000 on his mortgage (that started out at $400,000) so his home equity is:
$336,000
Sam – also bought in 2029. His home is now worth $608,000, but he still owes about 272,000 on his mortgage (that started out at $400,000) so his home equity is:
$336,000
The 3 kids have combined home equity of:
$946,000
All of it non-taxable. The family grew this aggregate wealth out of Mom and Dad’s $140,000, over 12 years from 2022 to 2034. At an interest rate of 5%, Mom and Dad would have paid about $7,000 each year on their HELOC, for a total cost of about $84,000.
But notice how their borrowing cost is more than covered by the value gain in their own home, over the same time. Since we tuned into their story in 2021, their own home’s value grew by $1,330,000, to the year 2034.
So, in simplified terms, for a total investment of $264,000, Mom and Dad have helped their family acquire $946,000 in after-tax wealth gain, over 12 years. Their total investment has grown by a factor of 3.58 times, reflecting roughly an annual compounding return of about 11% – after tax – on the portion of their long term savings and wealth they could dedicate to this plan.
This kind of wealth accumulation is available to many families in Canada, if our residential values keep rising. We want to see Live to Own™ benefit many families, so their younger generation are not victims of the constant upward creep in Canadian housing costs.