Planning, advice may help mitigate joint tenancy tax issues
By AdvocateDaily.com Staff
While property transfers can be a relatively straightforward estate planning tool, clients can inadvertently trigger tax liabilities if they make seemingly "insignificant" changes on their own without fully understanding the consequences, Vancouver corporate lawyer Jonathan Reilly tells AdvocateDaily.com.
“One of the things that we commonly find with people who have significant real estate holdings here is they definitely want to avoid probate fees because they can be very expensive as property values rise,” says Reilly, founder of English Bay Law Corporation.
Indeed, the probate fee in British Columbia is 1.4 per cent for the portion of the estate value over $50,000. A property transfer tax of approximately two per cent also applies when a change is made at the title office, with higher percentages applying depending on the value of the property or if an individual is considered to be a foreign buyer.
The Canada Revenue Agency (CRA) also levies capital gains tax on transactions.
As such, says Reilly, whose firm practises corporate/commercial, real estate and wills and estates law, clients are often interested in either reducing probate fees or somehow avoiding the tax that comes with the disposition of an asset.
“So the taxman generally gets his due or what he thinks is his due, and what you're really looking at is either deferring when the tax gets paid or finding a way that the tax gets calculated on a smaller base amount,” he says.
For many individuals who want to age in place, a common solution, says Reilly, is to put their house in joint tenancy with their children, as jointly-held assets pass outside of the estate. However, these transfers are considered a disposition for income tax purposes and for properties that are not the principal residence, the parent will be required to pay capital gains, he says.
In one recent example, he says clients wanted to place a rental property in joint tenancy with their adult son.
“The moment they do that, they create a capital gain because when they transfer that additional title interest to the son, that means they're disposing of that interest for their own purposes, and therefore, a capital gain is created,” Reilly says.
However, he explains transfers can be actual — where the title is changed at the land title office — or simply notional, where the registry wasn’t changed, but a beneficial transfer was made to a child who can help a parent administer the property. Each of these options carries different tax consequences.
“If you do the actual title transfer, the land transfer tax and the capital gains tax could be due," Reilly explains. "If you only do the beneficial transfer, the capital gains tax can be due — assuming it's not a principal residence as principal residences have exemptions from capital gains tax —but not the property transfer tax.”
Reilly says this flexible planning tool should be accompanied by a trust document that explains whether it is a real joint tenancy, or a joint tenancy for management purposes only, where the individuals aren’t actually transferring the title.
“That requires legal planning and some documentation,” he says.
There are a few risks with putting an adult child on the title, says Reilly, such as a claim to the property by their spouse.
“If that marriage falls apart, that person's spouse has a claim on 50 per cent of that interest," he says. "So there's another side that goes with it that also requires some considerable consideration as to whether you really want to put the child on as a true joint tenant or as someone who has been put on administer the property for the benefit of the parents and therefore, it wasn’t a real transfer."
In addition, those who put a minor, such as a grandchild, on the title as a joint tenant, they will be unable to sell or mortgage that property without the consent of the public guardian and a court order.
“You’re at a real risk of tying your hands with the property if you put anyone who's a minor on title,” says Reilly.
When couples reach age 65, there are other solutions they can implement, which can be powerful tools for those who can afford to pay the taxman now, he says.
“The two most common ones now being used are the joint spousal trust and the alter ego trust, Reilly says.
He says an issue with the joint spousal trust is when "you put the property in, assuming it's not the matrimonial property, you have a significant capital gains issue arise.
"The good news is that the property will pass on to the surviving spouse and the trust thereafter can be changed by adding a further beneficiary," says Reilly.
“The alter ego trust is where an individual creates a trust for their own asset of which they're the only beneficiary until they die," he says. "Again, the issue is the capital gains when you transfer the asset. So this is a balancing act that goes on where you want to save money either on probate or capital gains.
"You balance the reality of the nature of the property, what could be done with it going forward, the tax consequences, and so each one is an individual decision but they all are in fact unique, and each circumstance requires a lawyer to explore what is the client's end result that they want to achieve," Reilly says.
He says it is helpful for clients to put together a detailed list of the property they own before meeting with a lawyer, who will strive to get a sense of their client, how they built their life and assets, the family dynamics and what’s important to them.
The biggest risk for clients, says Reilly, would be to run out and make changes on their own with respect to changing the title to create a joint tenancy, which may lead to unintended tax liabilities.
“They think, ‘I'll just transfer my house into joint title and that'll just make everything really simple when I die, it just goes to my kids, and it's outside the estate so it avoids probate and it's just really easy,’” he says.
“And it's true — it will transfer the title to the kids easily and simply when you die," Reilly says.
"But what the client is not aware of is they just disposed of the property, which if it's their principal residence, it's not going to have a tax implication for them but will have a tax implication for their children because of the value the adjusted cost base of the property will be at the time the joint tenancy was set up, instead of being at the time of death and that could have a future significant tax impact for the kids," he says.
“Things like that could be addressed if it was done with a declaration of trust at the time, to make it clear what was being done, why it was being done, was the interest being disposed of, or was it being set up merely for management purposes,” Reilly adds.
Ultimately, clients should talk to their accountant and their lawyer before making any changes relating to title, he says.
“Clients often think they're not doing something significant and it's the accountant and lawyer who are put in the position of having to advise them that it is significant," Reilly says.