The article “How can you avoid a big capital gains tax bill when you die?” was originally published in Financial Post on September 2, 2022. PHOTO BY GETTY IMAGES/ISTOCKPHOTO.
Adding a child’s name to your assets won’t accomplish your goal of reducing capital gains tax.
Q: My wife Ava and I are in the process of gifting some money to our only child, Marlena. I know that in Canada I can do this tax free. But what are the consequences of adding Marlena’s name to the title on our principal residence, small rental property and cottage, as well as all our bank accounts? All three properties were purchased in the 1970s so there’s a hefty capital gains tax to be paid when we sell or die. We’d like to avoid this if possible. Marlena is 60, single and has one child, our grandson Henry. Is this a good way to save on paying capital gains tax? If not, what are some other ways we can avoid a big capital gains tax bill when we die? — Henry
FP Answers: There are several factors to consider when determining potential strategies to minimize tax. First, the principal residence exemption may allow you and Ava to avoid paying capital gains tax on some of the real-estate appreciation. The principal residence exemption allows a tax-free capital gain on a property you ordinarily inhabit. It does not need to be your primary home. It can be claimed for your cottage. But since most people’s homes are more expensive than their cottage, it is uncommon to claim it on a secondary property.
A couple can only have one principal residence between them, and one principal residence exemption claim in a given year. Since all three properties were purchased in the 1970s, claiming the exemption on your home will likely cause your cottage to be fully taxable.
The capital gains tax was not introduced in Canada until 1972, so only appreciation from 1972 onwards would be taxable. There used to be a $100,000 lifetime capital gains election, and, in 1994, many cottage and rental property owners bumped up the adjusted cost base of their properties to use some or all of that exemption. If you did, that may reduce some of the capital gain on your other properties.
The principal residence exemption is claimed when a property is sold. If you transfer a property to a family member, that is considered a deemed disposition, as if you sold the property. The same disposition occurs at death when you are deemed to have sold all your assets. Transferring an asset to a family member takes place at fair market value, so you cannot gift it or use an artificially low value to avoid taxes.
You may be able to get creative and transfer partial ownership each year for a number of years to your daughter to have small capital gains and keep your income in a lower tax bracket. But if you add Marlena to the title on your properties, there could be other issues related to the principal residence exemption.
For example, if you add Marlena to the title on your principal residence today and the value increases from now until you die, there may be tax to pay on the accrual of her share of the value from when she was registered on the title to when the property is sold.
If you live in a province where probate fees are high, joint ownership with your daughter may help avoid some probate costs by virtue of your share of the asset passing on to Marlena by rights of survivorship.
With real estate, there may not be much logistical advantage to owning them jointly. If Marlena is the executor for your estates, she may still be able to enter the home, gather an inventory of items, and even list the property for sale without owning the property. Though it could take several months for the probate process to be finalized, she may not necessarily have that much more flexibility by inheriting the home through rights of survivorship than being the beneficiary of the will.
With bank accounts, you may be susceptible to several risks if you add Marlena to these accounts. She would have full access to these funds as a joint account holder. Also, just like other assets such as your real estate, if Marlena is subject to a lawsuit or gets into a relationship and has a family law dispute, these joint assets could be subject to claims. If you have non-registered investment accounts and add your daughter’s name to them, it could result in a deemed disposition and capital gain on a portion of the investments.
Before adding Marlena’s name to any of your assets, please consider that the risks may outweigh the benefits. Talk to your accountant and estate lawyer to get their input. Given your primary motivation seems to be avoiding capital gains tax, adding your daughter’s name to your assets will unfortunately not accomplish that goal.
Andrew Dobson is a fee-only/advice-only certified financial planner (CFP) and chartered investment manager (CIM) at Objective Financial Partners Inc.