Formalize loans to your children

Parents sometimes provide money to children to help with education, buying a home, or starting a business. That money can be an outright gift that no one ever expects to be repaid or accounted for. Other times, the money can be a loan to the child or it can be an advance on the future inheritance.

Dealing with loans at death

If an outstanding loan is possible or expected at the time of your death, you can address it in your Will in one of three ways:

  • Forgive the debt, which means that it disappears without affecting your estate in any way. Even if you plan to forgive the loan, there may be advantages to formalizing the loan as you will see below.
  • Demand repayment of the loan. You might do this if the amount of the loan is a large part of your estate and the money is needed to provide an inheritance to other beneficiaries
  • Require the amount of the debt be deducted from the debtor’s share of your estate and then forgiven. You might do this if the amount of the loan is relatively small but you want to be fair to other beneficiaries who weren’t lent money.


If you have given money to a beneficiary with the expectation that the amount is an advance of the beneficiary’s inheritance, then you would require the amount of the advance be deducted from the beneficiary’s share of your estate. If this is your intention, then make sure you keep careful records of any amounts advanced to your beneficiaries.

Example of formalizing a gift as a loan

Calvin and Penny have one son, Howie, Instead of leaving money as an inheritance, Penny would like to give Howie some of his inheritance now and put the money towards the down payment down on his first home to get him started in life.

Upon some advice from his financial advisor, Calvin and Penny decided they would formalize the gift as a loan even though they intended to forgive the loan.

A couple of years later this proved to be a great strategy because Howie started dating Melanie and very quickly, Melanie moved in with Howie as they started to fall in love fast. Unfortunately, their relationship did not work out and things got pretty ugly. Melinda decided she wanted to take Howie for everything he was worth including the house. The good news is the original down payment was borrowed money (as per the promisary note) and there was no question that Calvin and Penny would get their money back before the house and other assets were split.

Good estate planning: Equalizing the estate

Rod and Lara have three adult children. Two children are financially independent. One child, Melody, is 34 years old and lives apart from her parents, but always seems to be short of money.

Melody has been many things in her life: a university student (to be a marine biologist), waitress, dance instructor (modern dance is her true love), retail clerk, dance studio owner, and homeowner (she was settling down). Melody has now returned to being a dance instructor.

Melody’s parents paid $16,000 for her uncompleted education, loaned her $40,000 for the dance studio, loaned her $80,000 to buy a house, and have given her money often to help pay her bills. The house was sold to pay the dance studio’s debts. Melody has outstanding balances on her credit cards, bank loans, and car loan. Melody has never repaid any money to her parents.

Now contemplating their estate planning, Rod and Lara would like to divide their estate equally between their children. However, they recognize that Melody has already been given much more financial support than their other two children.

In their Wills, the couple account for their support for Melody by:

  • ignoring the money paid for her education, since they paid for the education of their other children, too
  • ignoring the cash gifts, since they did not keep track of them
  • deducting the amount of any outstanding loans owing by Melody from her share of the estate and then forgiving the loans, and
  • treating any future cash gifts to Melody as advances of her share of the estate.

Of course, Melody’s share of her parents’ estate will be held in trust for her.

Often loans within families are treated informally but as you can see, there are merits to formalizing loans even if it’s family.


  1. The Blunt Bean Counter

    Jim, above you state “there was no question that Calvin and Penny would get their money back”.

    I am not sure it is that absolute. As you know I am a tax accountant and not a lawyer, so I do not have a definitive answer here, but when writing a blog on pre-nups a while back, after speaking to some lawyers and reading some cases I noted that the courts have discounted the value of the debt (mortgage or loan) where a judge has felt the debt was not valid and/or the child of the parent, who loaned the funds, would never be called upon to repay the debt to their parents.

    It is therefore imperative parents get proper legal advice to understand the best way to evidence the validity of the debt; which may involve their lawyer drafting a debt document that has an interest rate and default and payment terms, to establish the debt is a bona fide debt-ie: just a promissory note with an intention the debt may be forgiven if there are not marital problems may not be sufficent.

    • Jim Yih

      Point taken Mark! Nothing these days is 100% for certain so getting professional advice is always a good suggestion.

  2. Carolyn Bell

    Can you assist or can you offer a referral me to someone who can? Hi I am in need of some advice. Mom recently declared mentally incapable. POA is to be divided 50/50 between brother and sister. There is cash and a clear titled house – valued at $450,000 -that sister wants to buy. Sister has own home valued at $400,000 but no extra cash. Sister would like to draw-up agreement so she can purchase mom’s house ASAP. Problem: House is vacant. Mother living in seniors home. Sister will be a 50% heir it is written in the will. How can the sister draw up that agreement when mom does not technically have an estate yet and may not have for 20 years and would the arrangement be beneficial to the estate if she bought it now? How could that be builtin or ???What if the value of the property escalates before the “estate” happens? How can she purchase her mothers home for herself/buy without future problems encountered? Thankyou

    • Dave

      Danger! Danger! Danger!

      I am not a lawyer but have been a POA and a estate executor – 3 times.

      Do not under any circumstances allow the sister to have title to the home now, based I gather, on her future promises. (You indicate she has no money to buy it.)

      Your post lacks information to be able to meaningfully respond. GO TO A LAWYER who is experienced in estate matters.

      For starters the POA may not even allow the sale of real estate and the POA may not even be valid now that Mum is incapacitated.

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