For older Canadians considering their estate planning, minimizing probate fees may be a concern.
For many Canadians, their biggest asset by far is their principal residence. In some cases, it’s worth over a million dollars. For Ontario residents, whose estate administration tax (otherwise known as probate fee) is 1.5% on assets over $50,000, that probate fee on a $1 million property at death works out to $14,250.
Many people probably feel eager to save almost $15,000 per million in extra costs on an estate’s value.
So, what have Canadians been doing about it?
Well, for many years, a popular strategy we’d often hear about from clients was adding one or more kids as joint owners on the title of the property. The objective was that assets held in joint tenancy with rights of survivorship would pass to the surviving owner(s). In that case, the property would not be part of the parent’s estate and would therefore not be exposed to any probate fees.
Problem solved, right?
Financial planners and tax advisors in Canada would often be concerned about the consequences of implementing this strategy without sufficient consideration. Why? Well, there are many reasons for concern, but we’ll only discuss the tax implications right now.
In Canada, the date that there’s a “taxable event” can sometimes differ from the date a property was actually sold.
For example, if you’re a single or widowed parent with an only child, working on your estate planning, you might add your only child onto the title of the property. A potential unintended consequence of doing so could be that you’re deemed to have “sold” half the property at fair market value to your child. However, it’s your principal residence, so you claim the Principal Residence Exemption and pay no tax when this happens.
Your child may already own their own home which qualifies as their principal residence. Now, your child “owns” half your property, and the growth on that half may be taxable. If the value of the property is $1 million at the time of transfer, half the property could now have a “cost” for capital gains tax purposes of $500,000 and could continue to grow for many years. If the property increased in value another 20% before the parent passed, for example, the child could have $100,000 of taxable growth.
The child may be in their peak earning years at this point. If they were to sell the property after their parent passes, the total tax paid on this capital gain could be up to ~$27,000. That’s obviously more than the estimated $15,000 in probate fees, and therefore, the strategy could have backfired.
Now, let’s get even more interesting! Enter bare trusts, stage left.
In an ironic similarity to how the tax event and sale date of property in Canada are not always the same, it’s also true that the beneficial owner of a property is not always the same as who is on legal title. Just because a child is added on title, it doesn’t necessarily mean that the ownership really changed hands.
A beneficial owner means someone who has an interest in the property, excluding an interest that depends on the death of someone else (translation – an interest based on a future inheritance doesn’t count). Unless you clearly document that the beneficial ownership is changing when the child is added to the title, it may be that no true ownership transfer happened. This may mean that no disposition or deemed sale happened, and therefore saving 100% of the principal residence exemption for the parent.
However, it may be tough to argue the property should avoid probate fees if no disposition took place. In fact, the Ontario Estate Administration Return guide says: “Remember to include all property in which the deceased had a beneficial interest, even if the deceased did not hold legal title and legal title was held in another person’s name.” There is case law to support joint ownership between a parent and child constituting a resulting trust whereby the asset may be subject to probate and distributed based on the parent’s will – not passing to the child as the joint owner. This is one of many reasons to seek tax and legal input on joint ownership between a parent and child as an estate strategy.
The situation described above is called a “bare trust” arrangement. There are no annual tax implications for bare trusts.
“Bare trusts are where one person’s name is shown as the owner of an asset, but the asset really belongs to someone else” 1 .
Enter the new trust reporting requirements of Bill C-32, stage right.
Bare trusts, which can arise from the situation described above, will now be required to file a T3 tax return annually. For context, individuals file T1 returns, corporations file T2 returns, and trusts file T3 returns.
So, not only is it very important to clearly document the bare trust arrangement, but an annual tax return will now need to be filed. The return will need to provide information annually about who the key players are in the bare trust arrangement.
What happens if you are late to file or even worse, fail to file?
A minimum penalty of $100 and a maximum penalty of 5% of the maximum value of the property held during the year 2 . 5% of the property value is much more than the 1.5% probate fee we discussed earlier, so this could also backfire. That’s $50,000 on a $1 million property.
You will also likely have annual costs associated with filing the T3 returns.
If you’re in BC, you also need to report the bare trust according to the Land Owner Transparency Act 1 . Failing to disclose a bare trust could cost $25,000 or up to 5% of the assessed property value 3 .
What does this all mean?
Estate and tax planning have more considerations than ever, and it’s now more important than ever to speak to your financial planner and other professionals to ensure you’re compliant with the rules and to avoid unintended consequences.