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Part VI – Real Estate: Skipping to Other Generations When Planning Your Estate

With the value in real estate and other holdings, many Canadians have accumulated a significant estate that involves planning.  Talking about estate planning need not be uncomfortable.  For many, this naturally leads to who you would like to receive your estate – either family, friends, and/or charitable groups.  The process involves mapping out a plan that minimizes tax, while at the same time ensuring your distribution goals are met.

The second stage of the estate-planning process is when we ask for clients to bring a copy of the documents they currently have in place. We also obtain a copy of their family tree and information about current executor(s), representative, or other individuals currently named in the will.

To illustrate the process, we will use a typical couple, Mr. and Mrs. Gray, both aged 73. They last updated their wills 24 years ago.  They have what is commonly referred to as “mirror wills” where each leave their estate to their spouse in a similar fashion.  The will also has a common disaster clause that if they were to both pass away within 30 days that the estate would be divided equally amongst their three children.  We will refer this to as the “traditional method”.

Since they last updated their Will, all three of their children (currently aged 56, 54, and 52) have started families of their own. In fact, the Gray’s now have seven grandchildren between the ages of 11 and 32, and two great grandchildren (aged seven and three).  None of which were born when they last updated their Will.

In reviewing their will, we noted that this traditional method of estate distribution left everything to their now financially well-off adult children, to the exclusion of their grandchildren. We highlighted that the current will does not mention the grandchildren or great grandchildren. In exploring this outcome, they expressed they wanted to map out an estate plan that also assisted those that needed help the most.

The last time the Gray’s updated their will they had a relatively modest net worth, but in the last 24 years they were able to accumulate a significant net worth. We had a discussion with Mr. and Mrs. Gray that focused around the timing of distributing their estate.

The traditional method effectively distributed nothing today and everything after both of them passed away.

We discussed the pros and cons of distributing funds early. During our discussion, the plan that was created was combination of components, parts involved a distribution to the grandchildren based on certain milestones.  They also wanted to make sure their grandchildren obtained a good education.  The estate plan details that we outlined in the short term were relatively easy to put in place and were as follows:

  1. For the youngest members of the family they wanted to set up and fund Registered Education Savings Plans (RESP) for all eligible grandchildren and great grandchildren. The RESP contribution shifted capital from a taxable account to a tax deferred structure. This effectively results in income splitting for the extended family. Another added benefit is that RESP accounts would receive the 20 per cent Canada Education Savings Grant based on the amounts contributed.
  2. For the family members already in university, the plan was to assist with the cost of tuition and other university costs up to $10,000 per year per grandchild.
  3. For the grandchildren who were at the stage of wanting to purchase a principal residence, they wanted to set aside a one-time lump sum payment of $50,000 specifically to assist each grandchild with the down payment on a home.

One of the more challenging areas of the Gray’s estate plan dealt with their real estate. In addition to their principal residence, they also owned a recreational property in the Gulf Islands. The recreational property had some significant unrealized capital gains. It was important for the Gray’s to ensure both properties were kept within the family, if possible. We called a family meeting together where we outlined different options to achieve this goal. The key with this part of the estate plan was communication with Mr. and Mrs. Gray and their three children. We were able to obtain a clear plan that was satisfactory to all family members.

The finishing touch to a well-executed estate plan is ensuring the details are clearly documented in an up-to-date will.

 

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC. Call 250.389.2138. greenardgroup.com

This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in  this article. The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a 
division of Scotia Capital Inc., Member Canadian Investor Protection Fund.

Part V – Real Estate: Use Caution When Purchasing First Home

As of September 30, 2016, the price for a single family house has risen 22 percent, from September 30, 2015.  This could be discouraging for anyone not in the real estate market or for younger people looking to save for a down payment to buy a house.  With prices at historic highs, the temptation may be to rush into real estate before it goes higher.  Similar to the stock market, when you buy is extremely important.  Buying your principal residence is different which we will explain below.

The housing market is typically one area where using leverage (borrowed money) to purchase an asset has been good. Let’s walk through an example of leverage to purchase a single family home in Victoria.  According the Victoria Real Estate Board (VREB) the benchmark median value (September 2016) for a single family home in Victoria is $745,700.  Unfortunately, the exemption rules with respect to first time home buyers and property transfer tax are archaic and unrealistic in larger centres – property transfer tax of $12,914 would apply.   We think it would be beneficial if the province would adjust the qualifying value for exemption or at least allow some form of proration for affordable housing.  In Ontario, the Finance Minister  has announced that they will refund up to $4,000 from the land-transfer tax for first-time home buyers.

In addition to the purchase price, I estimate the following additional costs at a minimum: legal fees $750, house inspection $500, and house insurance $800. At a minimum, the immediate cash out-lay to purchase the home is $760,664.  To avoid CMHC insurance, a purchaser must put a down payment of 20 per cent, or in this case $152,132.80.  The remaining $608,531.20 must be financed or in other words, “leveraged”.

As noted at the very beginning, prices for Real Estate jumped 22 per cent in one year. It is, therefore, not unreasonable to stress test what would happen if real estate declined 10 per cent in one year.  If a 10 percent correction in real estate prices occurred, then this single family home example would decline $74,570.  Based on the down payment of $152,132.80, this would represent a loss on capital saved of 49 per cent.  Illustrating leverage to a younger person is essential in order to understand the associated risks.

In our first column we talked about the tax benefits of owning a principal residence – essentially no tax on capital gains. Canada Revenue Agency has a term called “personal-use property” which applies to a principal residence.  Any loss on the disposition/sell of a property which is used as a primary residence is deemed to be nil by virtue of sub-paragraph 40(2)(g)(iii) of the Income Tax Act.

If an investor entered the stock market with a non-registered account at a market high point before it pulled back, then, at least with the stock market, people are able to claim a capital loss and use it indefinitely.

Assuming a 25 year amortization and monthly payments, let’s do another form of stress test to see how a change in interest rates would impact payments on the $608,531.20 mortgage.   Assuming a mortgage at 3.2 per cent, the monthly payments would be $2,949.43.  If rates rise slightly to 3.7 per cent, the monthly payments would rise to $3,112.12.  In the near term it looks like rates will stay low, but a realistic view of the 25 year amortization should reflect rates rising off historic lows.  The best scenario would have the first time home buyer paying down as much of the principal before rates potentially rise to reduce the impact.

When interest rates go up, home prices tend to go down simultaneously. This would only compound the effect of the loss on capital saved in the short-term.

Taking a long-term vision and being sure that you can weather the stress tests above in the short-term are key factors prior to rushing in to buy a home. Similar to the stock market, we feel confident in the long-term that valuations will be higher than today.

Kevin Greenard, CPA CA FMA CFP CIM, is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC.  Call 250.389.2138. greenardgroup.com 

This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in this article. The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member Canadian Investor Protection Fund.

Part IV – Real Estate: Creating Cash Flow from the Proceeds from Selling Your House

Prior to selling your home, we encourage you to have a clear plan of what the next stage would look like.

If that next stage is renting, then meeting with your advisor ahead of time is recommended.   Once you sell, the good news is that you no longer have to worry about costs relating to home ownership, including property taxes, home insurance, repairs and maintenance.

Budgeting, when your only main expense is monthly rent, makes the process straight forward.  The key component is ensuring the proceeds from selling your house will be invested in a way that protects the capital and generates income to pay the rent.

The first step is determining the type of account in which to deposit the funds. The first account to fully fund is the Tax Free Savings Account (if not already fully funded). Then open a non-registered investment account for the proceeds.  Couples will typically open up a Joint With Right of Survivorship account.  Widows or singles will typically open up an Individual Account.

The second step is to begin mapping out how the funds will be invested within the two accounts above. A few types of investments that are great for generating income are REIT’s (Real Estate Investment Trust), blue chip common shares, and preferred shares.  Not only do these types of investments offer great income, they also offer tax efficient income, especially when compared to fully taxable interest income.

When you purchase a REIT, you are not only getting the benefit of a high yield, but you are generally getting part of this income as return of capital. The return of capital portion of the income is not considered taxable income for the current tax year.

As a result of receiving a portion of your capital back, your original purchase price is therefore decreased by the same amount. The result is that you are not taxed on this part of the income until you sell the investment at which point if there is a capital gain you will be taxed on only 50% of the gain at your marginal tax rate. You have now effectively lowered and deferred the tax on this income until you decide to sell the investment.

Buying a blue-chip common share or a preferred share gives you income in the form of a dividend. The tax rate on eligible dividends is considerably more favourable than interest income.

Another tax advantage with buying these types of investments is that any gain in value is only taxed when you decide to sell the investment and even then, you are only taxed on one half of the capital gain, referred to as a taxable capital gain. For example, if you decide to sell a stock that you purchased for $10,000 and the value of that stock increased to $20,000, you are only taxed on 50% of the capital gain. A $10,000 capital gain would translate to a $5,000 taxable capital gain.

We have outlined the approximate tax rates with a couple of assumptions.  Walking through the numbers helps clients understand the after-tax impact.

To illustrate, Mr. Jones has $60,000 in taxable income before investment income, and we will assume he makes $10,000 in investment income in 2016.  His marginal tax rate on interest income is 28.2%, on capital gains 14.1%, and only 7.56% on eligible dividends.

If Mr. Jones earned $10,000 in interest income, he would pay $2,820 in tax and net $7,180 in his pocket.  If Mr. Jones earned $10,000 of capital gains, he would pay $1,410 in tax and net $8,590 in his pocket.  If Mr. Jones earned $10,000 of eligible dividends, he would pay $756 in taxes and net $9,244 in his pocket.

The one negative to dividend income for those collecting Old Age Security (OAS) is that the actual income is first grossed up and increases line 242 on your income tax return. Below line 242 the dividend tax credit is applied.  The gross up of the dividend can cause some high income investors close to the OAS repayment threshold to have some, or all, of the OAS clawed back which should be factored into the after tax analysis.  The lower threshold for OAS claw-back is currently at $72,809.  If taxable income is below $72,809 then the claw-back is not applicable.  If income reported on line 242 is above $72,809 then OAS begins getting clawed back.  Once income reaches $118,055 then OAS is completely clawed back.

The schedule for dividend payments from blue chip equities and preferred shares is typically quarterly.  For REIT’s, it tends to be monthly. Once you decide on the amount you want to invest, then it is quite easy to give an estimated projection for after tax cash flow to be generated by the investments.

Preparing a budget of your monthly expenses makes it easy to automate the specific cash flow amount coming from your investment account directly into your chequing account.

Kevin Greenard, CPA CA FMA CFP CIM, is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria.  His column appears every week in the TC.  Call 250.389.2138. greenardgroup.com 

This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in this article. The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member Canadian Investor Protection Fund.

Part III – Real Esate: Benefits of Selling Real Estate Early in Retirement

In our last column we talked about CRA cracking down more on individuals who are non-compliant with respect to the principal residence deduction. Certainly individuals who have frequently bought and sold homes under the principal residence deduction will have to think twice and be prepared to be audited.

This article is really about the individuals who are contemplating a change in their life. Health and life events are often the two trigger points that have people thinking about whether to sell or not.   It can certainly be an emotional decision when it comes to that time.  Selling your home when you have control on timing when it is sold is always better than the alternative.

For our entire lives we have been focused on making prudent financial decisions and doing things that increase our net worth. There comes a point where you shouldn’t always do something that is the best financially.  If we only made decisions based on financial reasons you would never retire, you would work seven days a week, work longer days, and never take a vacation.  Throughout our working lives most people try to create a reasonable work-life balance.  In retirement I try to get clients to focus on the life part and fulfilling the things that are important to them.

Selling a principal residence could translate to a foolish move for someone looking at it only through net worth spectacles. I encourage clients to take off those spectacles and focus on what they truly want out of retirement and life.  At the peak of Maslow’s hierarchy of needs is self-actualization where people come to find a meaning to life that is important to them.   I think at this peak of self-actualization, many find that financial items and having to own a house, are not as important as they once were.

About ten years ago I remember having meetings with two different couples. Let us talk about the first couple, Mr. and Mrs. Brown who had just retired.  One of the first things they did after retiring was focus on uncluttering their lives.  They got rid of the stuff they didn’t need, and then they listed their house and sold it.  They then proceeded to sell both cars.  Shortly thereafter they came into my office and gave me a cheque for their total life savings.  Mrs. Brown had prepared a budget and we mapped out a plan to transfer a monthly amount from their investment account to their bank account.  They walk everywhere and are extremely healthy.  They like to travel and enjoy keeping their life as stress free as possible.  If any appliances break in their apartment it is not their problem, they just call the landlord.  Our meetings are focused on their hobbies and where they are going on their next trip.

I met another couple ten years ago, Mr. and Mrs. Wilson. They had also just retired.  They had accumulated a significant net worth through a combination of financial investments and they owned eight rental properties (including some buildings with four and six units).    At that time I thought they would have had the best of retirements based on their net worth.   The rental properties seem to always have things that need to get repaired or tenants moving out.  When I hear all the stories it almost sounds like they are stressed and not really retired.  Every year their net worth goes up.  Every year they get older, Mr. Wilson is now 75 years old and Mrs. Wilson is 72.  In the past I have talked to them about starting to sell the properties, to simplify their life and get the most out of retirement.   They are still wearing net worth spectacles and have not slowed their life down enough to get to the self-actualization stage.

My recommendation to clients has normally been to stay in their home as long as they can, even if this involves modifying their house and hiring help. This is assuming they have their health and the financial resources to fund this while still achieving their other goals.   Even in cases when financial resources do not force an individual to sell a house, the most likely outcome is that the house will be sold at a later stage in life and the proceeds used to fund assisted living arrangements.

Many people are house rich and cash poor. From my experience clients have two choices.  Option one is they can have a relatively stressful retirement trying to stretch a few dollars of savings over many years.  With this option you will likely leave a large estate.   Option two is selling the house and using the lifelong accumulation of wealth to make the most out of your retirement.    Although this option results in a smaller estate, you’re more likely to reach the self-actualization stage.

Kevin Greenard, CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC.  Call 250.389.2138. greenardgroup.com 

This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in this article. The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member Canadian Investor Protection Fund.

 

Part II – Real Estate: Mandatory to Report Sale of Principal Residence

In our last column we talked about the tax benefits for Canadians owning a principal residence. One of the positve parts about selling a principal residence in the past was that you didn’t even have to let Canada Revenue Agency know you sold it.

 

That is about to change.

 

On October 3, 2016, the Government announced that the Canada Revenue Agency now has a new reporting requirement for the sale of a principal residence. Starting with the 2016 tax year, individuals will be required to report basic information about the sale.   This new rule will require individuals who sell a home at any time during 2016 to report the disposition in their 2016 tax return.

 

The reporting of the sale will be done on Schedule 3 of your tax return. CRA will modify this form for the 2016 tax year.  It is anticipated that you will be required to report the date of acquisition, proceeds of disposition, and description of the property.

 

If the disposition is not reported to CRA, it will not be bound by the normal three-year limitation period for reassessing the disposition. The reassessment period for unreported dispositions will be extended indefinitely, regardless of whether the taxpayer’s failure to report the disposition was innocent or not. Prior to this change, the CRA could only reassess beyond the normal three year limitation period where the CRA could prove carelessness, negligence, willful default or fraud in failing to report the disposition.

 

Listed on the Canada Revenue Agency website, a property qualifies as your principal residence for any year it meets all of the following four conditions:

  • It is a housing unit, a leasehold interest in a housing unit, or a share of the capital stock of a co-operative housing corporation you acquire only to get the right to inhabit a housing unit owned by that corporation.
  • You own the property alone or jointly with another person.
  • You, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year.
  • You designate the property as your principal residence.

 

The actual rules with respect to the disposition of your principal residence have not changed other than the disclosure component. CRA has been increasingly focused on those non-compliant with the rules.

 

In British Columbia, the CRA doubled their efforts on auditing the real estate sector in 2015 and they have started a review of 500 high dollar value real estate transactions in this province.

 

The end goal for CRA is likely to uncover any unreported tax issues.   With computers, real estate information obtained from third parties can more easily be used in their risk-assessment tools, and analytical work.

 

It always amazed me over the years that CRA focused on the reporting of investment income on dividends, interest, and other income as it was mandatory that those amounts were recorded on a tax slip such as a T3 or T5.

 

For most of the years that I have been a Wealth Advisor, CRA did not have a mechanism to monitor the actual disposition of stocks in taxable accounts.

 

As Wealth Advisors we would send a realized gain (loss) report to clients which they would report in part 3 of Schedule 3. If clients failed to report this, CRA had no mechanism linked to a third party to monitor for non-compliance.  It is not until recent years that CRA has required financial firms to report the capital disposition of securities in taxable accounts to CRA. CRA now has a mechanism to monitor for non-compliance for sale of publicly trades shares, mutual fund units and the like.

 

Of course, the process of non-compliance is not black and white. A simple example is CRA targeting the short holding periods (the home may not qualify as capital property, a condition of being a principal residence), a house that was not ordinarily inhabited in each year of ownership by the vendor (another condition to qualifying as principal residence), or builders who build, then occupy, a house before selling (these would be considered inventory and not a capital property).

 

No doubt this change will result in many more audits and reassessments to deny the principal residence exemption.   Careful attention should be paid by trustees and executors to obtain a clearance certificates prior to distributing estates where there has been a recent home sale where the principal residence exemption could be questioned.

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC.  Call 250.389.2138. greenardgroup.com 

This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in this article. The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member Canadian Investor Protection Fund.

Part I – Real Estate: One of Canada’s Best Tax-Free Investments

Your principal residence is an investment in addition to being a place to live. Success is often associated with that sense of home ownership pride where you have a safe home for your family and where memories are created.

Most Canadians have committed more to their home than any other investment during their lifetime.

Prior to the introduction of the Tax Free Savings Account (TFSA) in 2009, there was really only one mechanism Canadians had to amass significant wealth on a tax free basis – owning your principal residence. The one benefit to real estate over the TFSA is that you’re not limited to the annual contribution limit.  Owning a principal residence and TFSA enables Canadians to maximize tax free wealth accumulation during their lifetime.

It is our belief that tax free is certainly better than tax deferral.   Because of the strong tax characteristics of the TFSA, we consider this a long term “investment” account that should be maximized each year.  Having a properly invested TFSA and owning real estate both protect you against inflation.  If inflation occurs, typically home prices rise from a replacement value perspective.

If TFSAs are invested in appropriate common shares then these also are typically inflation protected.

One aspect of both the TFSA and real estate that we like is that it creates forced savings resulting in greater net worth. Years of forced savings, through mortgage payments, results in debt being eliminated.

I always tell my clients that growing wealthy slowly is okay.  Paying down a mortgage over 20 years is one of those examples.  Although the annual limit for the TFSA may have initially seemed small, it all adds up and eventually begins to snowball over the years if contributions have been maximized.

Both the TFSA and your principal residence provide some flexibility if you want to make a change or need some liquidity. For example, if in a given year you need $20,000 out of your TFSA then you can simply withdraw the funds without tax or penalty.  The added bonus is that the government will let you put that same withdrawal amount back into your TFSA, provided you wait until the next year (assuming you had already maximized your TFSA contributions) or future years.  This replenishment feature does not exist with RRSP accounts.  If individuals take money out of an RRSP it is fully taxed in that year of withdrawal and the room does not get replenished.

Individuals can also sell their principal residence and replace it with another principal residence within reason. Our second column in our real estate series will deal with the new rules which were announced on October 3, 2016.

Estate planning is done for various different reasons, one of which is to reduce taxes during your lifetime. No two assets are better than your principal residence and TFSA when it comes to zero income taxes on the price appreciation.  Individuals can name a beneficiary on the TFSA to avoid probate even upon death.  With respect to one’s principal residence, couples typically avoid probate on the first passing if the home is registered in joint tenancy.  If an individual passes away with a principal residence registered solely in their name, then probate fees will apply.  Probate fees in B.C. are 1.4 percent of that portion of an estate in excess of $50,000 in value.  For a million dollar home this can be approximately $14,000.

In the majority of cases we are able to help our clients through the establishment of an estate plan that also assists them in avoiding this $14,000 probate fee. Our sixth column in our real estate series will go into real estate and estate planning in greater depth.

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC.  Call 250.389.2138. greenardgroup.com 

This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in this article. The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member Canadian Investor Protection Fund.