If you charged interest on the loan to your kids, they could deduct the interest on their tax returns, as they will have borrowed the money for investment purposes. You would have to report the interest income on your own tax returns. If you charge no interest, that is OK in this instance as well, Graham.
In order for your kids to treat the property as a rental property to deduct their mortgage interest and the other associated property costs on their tax returns, the rent you pay them must be equal to fair market rent. In other words, you cannot choose an artificially low rent to reduce their net rental income or increase their net rental loss.
Besides that, if you want to pitch your kids on this being an investment for them, the rent they are earning should be reasonably competitive.
I think your idea here has merit and is a great example of an alternative to a reverse mortgage. Seniors can do this without involving their kids, as well, potentially listing their home for sale with the condition that they want to remain as long-term tenants. It may limit the potential buyers for the home, but an investor may appreciate the opportunity to buy a home with a tenant who has money (from the house sale), who will treat the property well (having been the previous owner) and who may stay for a number of years (providing stable rental income). A real estate agent could help develop the proper listing details for the home and prepare a residential tenancy or lease agreement to sign at the same time as the agreement of purchase and sale is completed.
Real estate should be a complement, not a replacement, to other long-term investments
That said, there are a couple things I will question about this proposal, Graham. The result, from the sounds of it, is that you and each of your children will end up owning two real estate properties. Home ownership can be good for a lot of reasons and rental real estate can be a good way to invest. But whenever I talk to someone who is going out of their way to own multiple properties, I encourage them to consider whether that is the best approach.
Real estate has appreciated significantly in many Canadian cities, including Vancouver, Toronto and Montreal, in recent years. However, prices have decreased in other cities, particularly in Alberta. Rental real estate is likely to provide a comparable rate of return over the long run to a balanced investment portfolio. But real estate has significantly higher acquisition and sale costs (land transfer tax, real estate commissions, legal fees, etc.). As long as someone has a long-term time horizon and is not expecting real estate to make them significantly wealthier than stocks and bonds, especially given the already high prices in many Canadian cities, that is important to consider.
Your kids may have other opportunities, like Registered Retirement Savings Plan (RRSP) or Registered Pension Plan (RPP) tax deductions, which they forgo to buy this home from you. Or opportunities for tax-free growth in their Tax Free Savings Accounts (TFSA). If they have children—your grandchildren—and may forgo contributions to Registered Education Savings Plans (RESPs). They should be sure the one-third rental property ownership is a complement to their other long-term investment and financial goals, and not a replacement.
Calculate the opportunity cost
Finally, let’s say you build a vacation property for $500,000, as planned. If you sell your home and then have the choice to invest the proceeds in stocks and bonds, or build the property, there is an opportunity cost from not investing the proceeds, and building instead.