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How to transfer real estate property during your lifetime

30 March 2021 by National Bank
Real estate transfer

Are you looking to transfer real estate property during your lifetime to your children? Maybe your rental property or a cottage? First of all, yes it’s possible, but take the time to evaluate all the possible scenarios. There are many solutions available and they all come with their share of pros, cons, and major tax implications. Here’s an overview of your options. 

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Should you transfer your property during your lifetime or after your death? 

There are some advantages to transferring your real estate property during your lifetime to your loved ones, like to your children, for example. By going this route, you can rest knowing that you’ve helped a family member during your lifetime and experience the wonderful feelings that come with doing that. 

But there are some drawbacks. For example, if the money you would have made from selling your real estate property was part of your retirement strategy, you’ll have to review your plan. That’s another reason why you should weigh the pros and cons to make sure you’re in a good position to transfer your real estate property. Here are a few different scenarios. 

How do you transfer real estate property during your lifetime? 

1. What happens if you gift real estate property during your lifetime? 

Donating a building is the simplest way to transfer real estate during your lifetime. It’s free; as the donor, you accept to transfer the building to your child – the donee – with no financial compensation. As honourable as this it, it’s important to remember that from a tax perspective, the gift will be treated the same as any other transaction or transfer of ownership. 

That means that the donor and the donee are considered to have made a transaction at the property’s fair market value, even though no money was exchanged. This will immediately impact your taxes (capital gains tax and depreciation recapture), even though you’re gifting the property during your lifetime. 

On the other hand, tax authorities will consider your donees to have acquired the real estate asset at fair market value. 

Therefore, it’s important to do the math and talk to your children to make sure they’ll be able to afford the costs related to this kind of gift. Will they also be able to pay the legal fees and financial costs associated with the property, such as taxes? That’s why it’s important to talk about this with both an expert as well as your loved ones. 

Beware of selling real estate property for the symbolic price of $1

Let’s discuss the myth of selling real estate property to a loved one for the symbolic price of $1. Many incorrectly believe that this is a fiscally beneficial strategy for both parties. 

First of all, tax authorities consider $1 sales to be transactions where the parties do not want to declare the actual selling price. So, you’ll still be taxed on 50% of the capital gain based on the property’s market value. 

Let’s say you bought a house for $50,000 40 years ago, and it’s now worth $200,000. Even if you sell the property for $1, you’ll be taxed on 50% of the capital gain, i.e. on $75,000 (50% of $150,000). It’s a considerable amount and you’ll have to pay a lot of tax.

Plus, your loved ones will face the issue of double taxation. Tax authorities will consider your loved ones to have actually purchased the property for $1, so whenever they resell the $200,000 property, your children will be taxed on a $199,999 capital gain ($200,000 minus $1). 

2. What happens if you sell the property at fair market value? 

Many experts believe that the best way to transfer a building during your lifetime is by selling it. Usually, the cost should be paid in full to the seller when it’s sold. 

But what do you do if your child can’t afford it? Don’t panic – this happens all the time. It means you’ll have to handle both the sale and a loan: you could give your children a loan so they can buy your real estate property and keep the balance of sale. 

This loan will have to carry an interest rate equal to or higher than the market rate or the rate prescribed by the government. Interest must be paid to the seller no later than 30 days after the end of the related year. In addition, you’ll be able to spread out your capital gain over up to five years. 

Simply put, these are the pros and cons of this strategy:

Pros:

  • You’ll have an immediate inflow of cash. However, if you’re giving the buyer a loan, your cash inflow will be progressive. 
  • It’s a simple and inexpensive type of transaction. 
  • If there’s a loan involved, you can use your capital gain reserve to defer your taxes for up to five years. 

Cons:

  • You will immediately be taxed on the sale: Capital gain taxable at 50% and depreciation capture fully taxable.
  • If there’s a loan involved, your taxes will have to be paid using your other assets, as the sale price will not have been paid in full.  

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What are the other options for transferring real estate property? 

There are also other options for transferring real estate property. Here are a few: 

3. Creating a living trust

A living trust, or inter vivos (“between the living”) trust, is a separate entity from a tax perspective. The trust will therefore become the owner of the real estate property, not the constituent (you) nor the beneficiaries (your children).

This legal structure is mostly used for transferring housing stock or multiple rental properties. Why? Because the trust has the power to choose to tax a portion of the income, or all of it, within the trust itself or in the beneficiaries' hands.

This may be a good idea especially if the beneficiaries are taxed at a lower rate than the trust. The trust is taxed at the top marginal rate for individuals. 

The trust also provides a protection mechanism. It carries limited responsibility, as the constituent and the beneficiaries aren’t personally held responsible for losses that may be incurred by the trust. This structure also allows you to do income splitting. 

In terms of cons, there’s no rollover benefitting the trust, which is to say that there may be a tax impact, except in certain rare situations. 

4. There are also other options

An advisor can also make other suggestions depending on your situation. In particular, you can opt for joint property of the asset with right of survivorship, which allows you to sell 50% of a real estate property to your child so they may co-own it with you until your passing. 

There’s also estate freezing through a business corporation, which is mostly aimed at for housing stock owners who are planning their estate. 

It requires more organization, but an estate freeze through a business corporation is another option. An expert can help you figure this out and find the best strategy for your particular situation. 

How do you set up a transfer of your real estate property? 

Beyond transferring your rental property or your cottage, you may also be wondering how to distribute your assets among your children, if you have more than one. 

How do you make sure everything is distributed equitably? First, keep in mind that “equal” and “equitable” are two different things. Sometimes, it’s better to be equitable rather than equal. For example, one of your children may not be interested in owning 50% of a rental property, while the other may be disappointed to have only inherited half.  

Gifting your building to one and your life insurance and investments to the other may make everyone happy, for example. 

The key to success for a transfer or in estate planning is discussing it beforehand with your loved ones. Get your family together, let your children know about your intentions, and start a conversation. A financial planner can also help you plan your estate. 

Finally, if you want to transfer a real estate property in your lifetime, the important thing to remember is that there’s no one-size-fits-all solution. There are many different strategies you should evaluate depending on your personal and financial situation, and those of your children. Want to talk to one of our experts about your goals? We’re here to answer your questions.

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