Sometimes, we are under the wrong impression that real estate purchases are one-time deals – we mistakenly think that the only relevant factors are the expenses and tax implications at the moment.
However, at Varity Law, after helping countless families with their probate process and estate home sales, time and time again we showed them that real estate requires long-term planning. There is a big difference between having a plan and not having a plan, especially when it comes to mitigating income taxes, probate taxes, and mortgage penalties.
In this blog, Sabrina Ding, experienced lawyer at Varity Law, will teach everyone about some basic estate planning strategies, especially when it comes to your real estate property.
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Income Taxes
As many home-owners and real estate investors know, only your principal residence is tax-exempt. That means, when you sell your principal residence, you do not need to pay any income taxes on the sale proceeds.
However, when you sell an investment property, you do need to pay capital gains on the sale proceeds. In theory, you could claim that you have more than one principal residence. But in practice, that may be hard to prove to CRA – for instance, you may need to show that you actually live in Property A from January to June, and then Property B from July to December. Of course, being a law firm, we do not provide income taxes services, so for any further questions in this regard, please consult a licensed accountant.
Based on this idea, one can see how passing down real estate properties could result in a lot of income taxes payable. For instance, let’s say a couple own a principal residence, and their son own his principal residence. After the couple passes away, their son inherits their property. Now he has two properties – and likely CRA will regard one of them as an investment property – meaning he must pay capital gains when he sells it.
Nevertheless, there is a way to avoid this. If the son wants to sell the estate property right away, then he can leave it in the estate. Imagine that the estate is a person, when the estate sells its principal residence, then it is tax-exempt as per usual. Afterwards, if the son is the only beneficiary, he can take the sale proceeds tax free, because in Canada, inheritance is not taxed at the hands of beneficiaries.
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Probate Taxes
Although Canadian beneficiaries are lucky enough to not pay inheritance tax, the estate itself must still pay for probate taxes and final income taxes.
Probate taxes are calculated based on the value of the estate – and unfortunately, only mortgage may be deducted from this value, all other debts cannot be used to deduct against taxable estate value.
Not to worry, there are still 3 ways to mitigate against probate taxes:
- Joint Accounts – any assets that are held jointly with the beneficiary (e.g. joint tenants on a real estate deed, or joint bank account) do not form part of the estate – so it does not require probate nor probate taxes payment, and can be automatically inherited by the beneficiaries; however, the moment your account is joint with your beneficiary, he/she also has the power to use the funds in that joint account – his/her power to do so does not active after your passing away; thus, this method is only useful if the beneficiary is mature enough to handle this temptation.
- Any financial products with designated beneficiaries (e.g. life insurance, TFSA, RRSP) can avoid probate and probate taxes. Unfortunately, not all types of assets can have a designated beneficiary.
- Trusts are also exempt from probate. Using the example from (a), the parents can instead set up a trust which would only activate upon both of their passing. When that happens, their son may claim the property using the trust, without having to go through probate and pay probate taxes.
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Mortgage Inheritance
In general, there is no mortgage inheritance in Canada. This is because most loans are tailored towards the original borrowers (considering their specific income and credit). It is extremely unlikely for a bank to transfer the same mortgage loan from the parents to the son.
There lies the problem – upon the parents’ passing, the bank may ask the son to immediately pay back all outstanding mortgage. Facing this horrible predicament, the son have 3 choices:
- He could apply for a new mortgage under his name, and use the money from that mortgage to pay off the old mortgage under his parents’ name. However, this is not an ideal solution, because it is unsure whether the son may qualify for a big enough mortgage to pay off the old mortgage – and even if he can succeed in that, he may get a new mortgage with unfavourable interest rates and terms.
- He can sell the estate property – but during the sale process, he would either need to pay the monthly mortgage out of his pocket, or the bank will stack up on penalties and interests. Usually, upon knowing that the borrowers passed away, the bank will not sell the estate property as long as the son has a plan to sell the property himself – but the bank will unlikely waive any interest and penalties during the sale process.
- The most ideal situation is if the parents did estate planning – and they bought life insurance or mortgage insurance to address this issue. As insurance proceeds may be received by the son without going through probate, he can use those funds to pay off the outstanding mortgage. Then, whether he wants to keep the property, or sell it slowly – he can do so at his own pace without the pressure and penalties from the bank.
Conclusion
In Canada, estate planning is essential for ensuring a smooth and cost-effective transition to your beneficiaries. Having a plan and not having plan makes a world of difference, especially when it comes to income taxes, probate taxes, and debt repayment.
Varity Law have already helped countless families plan and complete their Real Estate and Wills & Estate matters. We invite interested families to contact us at 905-597-9357 or hello@varitylaw.ca to book an initial free consultation.
