For many Canadians the majority of their wealth is held in personally owned real estate. For most this will be limited to their principal residence however, investment in recreational and real estate investment property also form a substantial part of estates. Due to the nature of real estate, it is important to do estate planning to realize optimum gain and minimize tax implications.
Key Considerations for Real Estate Investment
- Real estate is not a qualifying investment for the purposes of the Lifetime Capital Gains Exemption
- Leaving taxable property to a spouse through a spousal rollover in the will defers the tax until the spouse sells the property or dies
- Apart from the principal residence, real estate often creates a need for liquidity due to capital gains, estate equalization, mortgage repayment or other considerations
- Professional advice is often required to select the most advantageous ownership structure (i.e., personal, trust, holding company).
What you Need to Know About Capital Gains Taxes
- Upon the disposition (sale or transfer) of an asset there is income tax payable based on 50% of the capital gain of that asset.
- Capital gains taxes can be triggered at death unless the asset is left to a spouse in which case the tax is deferred until the spouse sells the asset or dies.
- In addition, there may be probate fees levied against the estate at death.
Why is Estate Planning Important?
It is recommended that family issues (including estate equalization) be addressed with certain types of real estate assets. Estate planning can organize your assets with the objective to ensure that at your death they are distributed according to your wishes:
- to the proper beneficiary(s),
- with a minimum of taxes and costs
- and with the least amount of family discord.
Tax and Estate Planning Strategies for Various Real Estate Holdings
- If your home qualifies as a principal residence, there is no tax on any capital gains upon sale or transfer of the property. An individual can only have one principal residence and the same holds true for a family unit (for example, both spouses have only one principal residence between them).
- If the property is held as joint tenants, upon the death of a spouse the ownership automatically remains with the surviving spouse. Since this arrangement is not governed by the will, there are no probate fees incurred. Upon the death of the surviving spouse his or her will dictates who will receive ownership of the home (usually one or more of the children).
- In preparing your estate planning for your principal residence, you may wish to ensure that you have sufficient liquidity to cover the cost of any property tax deferral program that you have exercised. This is especially important if the home is intended to be retained by the beneficiary(s) and you don’t want to burden them with the significant cost of repayment.
- Planning for the beneficiaries to retain the property often creates discord if the children are not all in agreement about the final disposition of the house. Should you just wish to leave the home to one child and not to the others consider estate equalization and use cash, other assets or life insurance as a replacement to the interest in the home.
- If the sale, transfer or deemed disposition at death of the cottage or other recreational property results in a capital gain, that gain will be taxable. Selling at a loss will create a capital loss. As in the principal residence, ownership could be in joint tenancy which will defer the tax. The tax will also be deferred if the property is left to your spouse in your will.
- There may be some concern that if the property is left outright to the spouse and the spouse remarries the property may ultimately end up with someone who was not intended as a beneficiary. To avoid this, a trust could be used to hold ownership of the property. A spousal trust created in the will also accomplishes this while at the same time maintaining the spousal rollover to avoid tax on the gain of the property. In addition, the spousal trust has an added advantage in that it allows the testator to specify who will inherit the property on the spouse’s death.
- Much like the family home, considerable thought should enter into the decision as to how to bequest or liquidate the family cottage or recreational property in an effort to maintain family harmony.
Real Estate Investment Property
- Sale, transfer or deemed disposition (at death), usually will result in a capital gain or capital loss. If the property in question is rental property depreciation (known as capital cost allowance) may be claimed as a deduction against rental income. At death, if the fair market value of the rental property exceeds its undepreciated capital cost, there will be a tax payable on the recaptured depreciation. A value of less than undepreciated capital cost will create a capital loss which, in year of death, can be deducted against other income.
- If the property in question is performing favourably as an investment, it may be desirable to leave it to the surviving family members. In this case, it is recommended that any liquidity requirement for taxes, costs etc. be funded to alleviate the financial burden.
- From a planning point of view, it may be advisable to own commercial real estate through a holding company. Depending on the circumstances the same could be true with rental property. If required, the shares in the holding company could be owned by a Family Trust which may have a beneficial income splitting result.
Solving the Liquidity Need
As discussed, the majority of the taxes resulting from the disposition of real estate upon death can be deferred until the demise of the surviving spouse. The same is true for most of the estate equalization considerations with the family. The most cost effective method in providing the necessary liquidity in these situations is the use of second-to-die joint life insurance. This vehicle provides tax free cash at the second death. Naming a beneficiary bypasses the will and is not subject to probate. In addition, the proceeds are protected against creditor claims. Insurance provides for a guaranteed low cost alternative to the issue of satisfying the liquidity need at death.
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