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Real estate is an important asset for many Canadians. Giving real estate to your next generation can be an important facet of your estate plan, whether you’re passing on to your family, your longtime cottage that’s been in the family for generations, or an investment property.
However, it’s not always as simple as giving the property to the beneficiaries in a will. Although there is no direct inheritance tax in Canada, the transfer of real estate may have significant financial ramifications. Families can avoid unexpected obligations and make wise decisions by being aware of these regulations.
Why Passing Down Real Estate Requires Careful Planning
Others think that the funds will pass on to their beneficiaries tax-free. As a general rule, beneficiaries do not have to pay taxes on a direct inheritance; however, the estate may be taxed before any assets are distributed to the beneficiaries.
Capital gains are the biggest tax liability in many instances. An asset’s value may have gone up over time, and this increase in value may be taxable at the time of transfer or on death.
With proper planning, families can help plan for these commitments and maintain more wealth for future generations.
Understanding Canada's Deemed Disposition Rules
The tax system in Canada is based on the concept of “deemed disposition on death. The Income Tax Act generally assumes that a deceased person has sold a capital property just prior to his or her death at its fair market value.
This is a general rule and applies to a variety of properties, such as:
- Principal residences
- Cottages and vacation properties
- Rental properties
- Investment real estate
Capital gain may result if the property’s fair market value is more than its adjusted cost base.
For instance, if a person bought a cottage for $200,000 some years ago, and it is valued at $900,000 at their death, then the net estate on the person’s death is $700,000. The estate might have to report a capital gain on the $700,000 gain in value (unless an exemption applies).
This means that it is possible to have a substantial tax bill, depending on the situation.
When Capital Gains Tax May Apply
- Principal Residence Exemption
The principal residence exemption is one of the most beneficial tax advantages that Canadian homeowners can enjoy.
In general, where a property is used as an owner’s primary residence during every year of its ownership, a portion or all of the capital gain from that property might not be taxable.
But when there are complications, such as when an individual has more than one house, for example, a townhouse and a family home. Only one property is eligible to be considered as a principal residence for an individual for any one year, so it can be necessary to plan carefully to be able to make the right choice of designation.
- Cottage and Vacation Properties
Family cottages can be a significant burden on an estate’s taxes.
The value of many cottages has increased significantly over the years. These properties are often passed on to the children or grandchildren of the family, but the deemed disposition rules can result in paying capital gains tax even if the property hasn’t been sold.
If there is not enough cash or other liquid assets in the estate to cover the resulting tax liability, the estate may face difficulties and may need to sell the cottage or other assets to fund the tax.
- Rental and Investment Properties
Seldom does the principal residence exemption apply to rental and investment properties.
This means the value of the property could increase, which would then be taxable at the time of death or transfer.
Other factors to consider with rental properties are recapture of capital cost allowance if capital cost allowances were previously taken.
What Happens When You Gift Property During Your Lifetime?
Others may want to give their property to their children while they are alive to avoid probate or estate administration issues.
However, giving gifts of property doesn’t always totally remove the tax implications.
In many cases, the Income Tax Act considers a gift of capital property to be a disposition at fair market value. If there’s no money changing hands, this could lead to the payment of capital gains tax.
For instance, if a rental property is valued at $1 million but the adult child is the new owner, that transfer might be considered a sale and result in taxes on any appreciation.
It is therefore very important to consider how you are going to give the gift before you make a transfer, so that you can consider how best to do it.
Tax Considerations for Joint Ownership and Transfers to Children
Another possible way to ease the transfer of property is for families to have joint ownership.
Joint ownership can provide some administrative advantages, depending on the situation. It can also have legal and tax repercussions.
Issues that could come into consideration include:
- Beneficial ownership
- Attribution rules
- Capital gains implications
- The process of administering probates and estates.
Also, the inclusion of an adult child under a property’s title does not remove any future tax liabilities.
Proper documentation and professional advice can help ensure that the ownership arrangement is structured appropriately and achieves the family’s intended goals.
Estate Planning Strategies to Reduce Future Tax Burdens
Taxes can not completely be avoided, but planning ahead can help control future tax liabilities.
Some strategies that might be used are:
- Regularly checking ownership arrangements
- Reviewing the application of the principal residence exemption.
- Establishing a liquidity plan for the estate.
- Working with your overall estate goals in mind when planning your taxes
- Assessing appropriateness of lifetime transfers
Each family is different, and what works for one family may not be optimal for another.
Common Mistakes Families Make When Transferring Real Estate
There are several typical pitfalls when it comes to giving property that can make the tax burden more significant:
- Assuming that there are no taxes on inherited property in Canada.
- Failing to consider any capital gains obligations
- Not keeping property valuation/records up to date
- Transferring property without understanding tax implications
- Delaying the conversation about estate planning
By being proactive in responding to these issues, uncertainty and loss of family wealth can be minimized.
When Professional Tax Advice Becomes Essential
Many people own a home, and it is a substantial part of their net worth. Transfers of the property can impact the estate and future generations for years to come.
Tax results can vary greatly based on your individual property type, ownership structure, and family situation, so it can be advantageous to get professional advice.
An integrated approach that considers both tax and estate planning can aid families make informed decisions and minimize unexpected tax and legal consequences.
Final Thoughts
Real estate often has some tax implications that don’t always come to mind when passing it on. While Canada doesn’t have an inheritance tax, capital gains taxes and deemed disposition rules can have a major impact on an estate.
For homeowners, whether owners of a principal residence, a much-loved family holiday home, or an investment property, there are ways to protect your investments and ensure greater certainty for your beneficiaries with proactive planning.
Faber LLP’s professionals help individuals and families with complex tax and estate planning issues. We can help you create strategies that could help you transfer your wealth smoothly and tax efficiently to your heirs based on your individual situation and goals.