He recently had a MAJOR falling out with our next door neighbors whom we were very closed to. They have 2 kids as well. How do I tell my youngest that he can't play with those kids anymore?
My situation is a bit different than yours so it might not be that helpful but thought I would share just in case.
I had a falling out with a friend who was very unhealthy for me in 2010. Our daughters were very close and saw each other often before the issues arose and it was, in fact, my daughter's affection for her friend that kept me involved in the toxic friendship for as long as I did. My friend had taken to "jokingly" calling me a "baby hater" in front of our children all while knowing full well we made the painful choice to have an only child after multiple pregnancy losses, including a second trimester loss. She also poked fun at the fact that I experience frequent urination due to chronic health issues I suffer with and did so loudly so everybody around us, including my daughter, could hear. It was very demeaning but look past these issues and others I did for the sake of the friendship between our daughter's.
Finally a the proverbial last straw came and with it the knowledge of just how little she cared about me and my child. I ended the friendship in a way I wish I hadn't: dramatically and quickly rather than slowly and simply letting everything drift apart as I would have done had circumstances been different.
In the months that followed my daughter asked often for her friend and my husband and I decided explain the truth in an age appropriate way, preserving the dignity of all involved and not casting a dark shadow upon either her friend or her friends parents as my daughter like them all and we wanted her to maintain a happy memory of people she had spent a lot of time with and enjoyed. We told her that sometimes people "move away" emotionally to different stages of life and no longer share life together, just as they physically move houses and we don't get to see them anymore. No matter what happens to cause a parting, they can always live in our heart and be reflected on fondly in our memories for they are always part of our lives even if they no longer come over. Many discussions were had and eventually my daughter began asking about her friend less and less.
My daughter still occasionally asks about her friend and her friend's family and we look at pictures and talk about all of the things we did together.
I don't know if such an explanation could really work due to proximity between you and the people in question but simply offer it for what it might be worth.
Unschooling Mother to S, my 6yo "Moon Farmer"
What about telling the truth?.
Tell your kids that something happened. tell them that the parents are not friends anymore, what will make it harder for the kids to meet. tell them that it takes time to heal from a hurt, and maybe in the future they will get together again.
Take into consideration that they probably will have a lot of feeling coming up around that and they will need a safe place to take them out (you :-)). let them cry and get mad. sometimes after taking all out it doesn't seems so bad anymore.
We are going through something similar, so sorry, no advice, but we can empathize. We've always liked our neighbors, as they seem to be friendly enough, and their kids are nice. Once DS was old enough to "play" with their kids, we started having impromptu playdates on occasion when we were all outside together. They brought their kids over before trick-or-treating started so we could take pictures, that sort of thing. So we invited them to our house for a holiday dinner. They are a different religion than we are, and are much more religious than we are, but we like to share our family traditions with people we like and thought that would be a good way to expose (all) the kids to our differences. We are NOT religious and would never push our beliefs on anyone. Our holiday dinner was really just that -- dinner. No praying, no discussion of religious beliefs (other than whatever questions they had). Just dinner. At the last minute, they got a babysitter for their kids and came just themselves, which was awkward, b/c being a holiday dinner we had bought Christmas gifts for the kids to open and play with while the adults visited. We had invited another family (also a different religion) and their kids, and thought everyone would have a good time. But then the neighbor kids didn't even get to come, so we sent the gifts home with the parents. (Just puzzles and books, nothing related to the holidays.)
They never spoke to us again. They didn't thank us for having them over, the kids didn't thank us for the presents, nothing. They avoid us like the plague when we happen to be walking out to the mailboxes at the same time. I have NO idea what went wrong, other than that maybe b/c they are so invested in their religion that they are uncomfortable with being friends with us b/c of ours. DS always asks when he can play with them, and I have to say they're busy, or not home, or whatever. I can't imagine having to tell him they don't want to talk to us b/c of our religion, when he's just figuring out what that even means. (He's trying to understand Christmas and who celebrates it and who doesn't and why. It's more confusing b/c we still exchange holiday dinner parties with the other family that was here that night and so we do "celebrate" both holidays in that respect, it's just that we don't observe them both.)