My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, July 25, 2022

The Best (Most read all-time) of The Blunt Bean Counter - Transferring Property Among Family Members - A Potential Income Tax Nightmare

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. Today, I am re-posting my most read blog post of all-time (over 200,000 page views); a post on transferring property amongst family members. As you will read, there is potential for some strange income tax results and care must be taken when transferring property to family members. I thus strongly suggest you obtain professional advice before undertaking any such transfer.

Transferring Property Among Family Members - A Potential Income Tax Nightmare


In today’s blog post, I will discuss the income tax implications relating to the transfer of property among family members. These transfers often create significant income tax issues and can be either errors of commission or errors of omission. Over my 25 years as an accountant, I have been referred some unbelievably messed up situations involving intra-family transfers of property.

Transfers of Property - Why They Are Undertaken


Many individuals transfer capital properties (real estate and common shares, being the most common) in and amongst their families like hot cakes. Some of the reasons for undertaking these transfers include: (1) the transferor has creditor issues and believes that if certain properties are transferred, the properties will become creditor protected (2) the transferor wishes to reduce probate fees on his or her death and (3) the transferor wishes to either gift the property, transfer beneficial title or income split with lower-income family members.

I will not discuss the first reason today because it is legal in nature. But be aware, Section 160(1) of the Income Tax Act can make you legally responsible for the transferor's income tax liability and there may be fraudulent conveyance issues amongst other matters.

Transfers of Property - Income Tax Implications


When a property is transferred without consideration (i.e. as gift or to just transfer property into another person's name), the transferor is generally deemed to have sold the property for proceeds equal to its fair market value (“FMV”). If the property has increased in value since the time the transferor first acquired the property, a capital gain will be realized and there will be taxes to be paid even though ownership of the property has stayed within the family. For example, if mom owns a rental property worth $500,000 which she purchased for $100,000 and she transfers it to her daughter, mom is deemed to have a $400,000 capital gain, even though she did not receive any money.

There is one common exception to the deemed disposition rule. The Income Tax Act permits transfers between spouses to take place at the transferor’s adjusted cost base instead of at the FMV of the capital property.

This difference is best illustrated by an example: Mary owns shares of Bell Canada which she purchased 5 years ago at $50. The FMV of the shares today is $75. If Mary transferred the shares of Bell Canada to her brother, Bob, she would realize a capital gain of $25. If instead Mary transferred the shares of Bell Canada to her husband, Doug, the shares would be transferred at Mary’s adjusted cost base of $50 and no capital gain would be realized. It must be noted that if Doug sells the shares in the future, Mary would be required to report the capital gain realized at that time (i.e. the proceeds Doug receives from selling the shares less Mary’s original cost of $50) and Mary would be required to report any dividends received by Doug on those shares from the date of transfer.

When transfers are made to spouses or children who are minors (under the age of 18), the income attribution rules can apply and any income generated by the transferred properties is attributed back to the transferor (the exception being there is no attribution on capital gains earned by a minor). The application of this rule is reflected in that Mary must report the capital gain and any dividends received by Doug. If the transferred property is sold, there is often attribution even on the substituted property.

We have discussed where property is transferred to a non-arm’s length person that the vendor is deemed to have sold the property at its FMV. However, what happens when the non-arm’s length person has paid no consideration or consideration less than the FMV? The answer is that in all cases other than gifts, bequests and inheritances, the transferees cost is the amount they actually paid for the property and there is no adjustment to FMV, a very punitive result.

In English, what these last two sentences are saying is that if you legally gift something, the cost base and proceeds of disposition are the FMV. But if say your brother pays you $5,000 for shares worth $50,000, you will be deemed to sell the shares for $50,000, but your brothers cost will now only be $5,000; whereas if you gifted the shares, his cost base would be $50,000. A strange result considering he actually paid you. This generally results in “double taxation” when the property is ultimately sold by the transferee (your brother in this case), as you were deemed to sell at $50,000 and your brothers gain is measured from only $5,000 and not the FMV of $50,000.

Transfers of a Principal Residence - The Ultimate Potential Tax Nightmare


I have seen several cases where a parent decides to change the ownership of his or her principal residence such that it is to be held jointly by the parent and one or more of their children. In the case of a parent changing ownership of say half of their principal residence to one of their children, the parent is deemed to have disposed of ½ of the property. This initial transfer is tax-free, since it is the parent’s principal residence. However, a transfer into joint ownership can often create an unforeseen tax problem when the property is eventually sold. Subsequent to the change in ownership, the child will own ½ the principal residence. When the property is eventually sold, the gain realized by the parent on his or her half of the property is exempt from tax since it qualifies for the principal residence exemption; however, since the child now owns half of the property, the child is subject to tax on any capital gain realized on their half of the property (i.e. 50% of the difference between the sale price and the FMV at the time the parent transferred the property to the child, assuming the child has a principal residence of their own).

An example of the above is discussed in this Toronto Star story that outlines a $700,000 tax mistake made by one parent in gifting their principal residence to their children.

I have been engaged at least three times over the years by new clients to sort out similar family transfer issues.

Transfers for Probate Purposes


As noted in the first paragraph, many troublesome family transfers are done to avoid probate tax. Since I wrote on this topic previously and this post is somewhat overlapping, I will just provide you the link to that blog post titled Probate Fee Planning - Income Tax, Estate and Legal Issues to consider.

Many people are far too cavalier when transferring property among family members. It should be clear by now that extreme care should be taken before undertaking any transfer of real estate, shares or investments to a family member. I strongly urge you to consult with your accountant or to engage an accountant when contemplating a family transfer or you may be penny wise but $700,000 pound tax foolish.
 
Note: I will not be answering any questions on this "best of" post. The original post has 268 comments. Please scan those comments; it is likely your question has already been addressed.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.


Monday, July 11, 2022

The Best of The Blunt Bean Counter - “My Kids Will Never Fight Over My Estate”

This summer, as per tradition, I am re-posting the "best of" The Blunt Bean Counter blog while I work on my golf game (it needs more work than usual :( Today, I am posting a May 2021 blog titled "My Kids Will Never Fight Over My Estate". I decided to re-post this blog because I was recently told of the acrimony caused in a family because a parent did not specifically allocate personal assets in their will as promised/told to their children during the parent's lifetime.
 
My Kids Will Never Fight Over My Estate

In December 2019, I reviewed the book “Bobby Gets Bubkes: Navigating the Sibling Estate Fight.” In that book, estate lawyer Charles Ticker attempts to explain how to avoid, or at least limit, sibling estate fights when drafting your will. In the comments section to that post, Michael James, who writes the excellent finance blog Michael James on Money, made the following remark:

Sounds like an interesting book. Sadly, I'm guessing most people incorrectly think that their own kids would never squabble in these ways, so they think they don't need to follow the book's advice.
Michael’s “guess” is very perceptive. Based on my experiences over 35 years as an accountant, many parents look at their children and their sibling relationships with rose-coloured glasses or, in some cases, with blinders. As a consequence, they ignore clear warning signals that their children have significant sibling rivalry issues and don’t work well together. In some cases, you can almost predict a sibling estate fight.

Let me be clear. I am not saying every estate has a sibling fight. Many families settle and distribute the estate in accordance with the will and their parent’s wishes with little acrimony. However, this is far from the case in many estates, as human nature can turn ugly when there is money and sentimental items at stake, especially where sibling issues have reared their heads during the parents’ lifetimes.

Today, I am going to list factors in no particular order that can cause siblings to squabble over an estate.

Why siblings squabble over an estate


  • Greed – Very simply, money causes some people to lose their minds and perspective. This can destroy sibling relationships.
  • Grabbers – I have seen this many times. One child “grabs,” or takes, items before the will is considered, or even ignores the wishes of the will, which starts a spiral of hurt and mistrust among the siblings.
  • Sentimental items – Children often fight over these items. In many cases, this issue can be avoided if the parent simply provides a specific item-by-item allocation in their wills of sentimental items such as jewelry. Parents can also cause huge sibling issues when they promise or tell a child they will receive a certain item and then do not specifically allocate that item to the child in their will—or worse yet, allocate the item to another child. Parents: always make your will consistent with what you have told your children, or communicate the change to them.
  • Grandchildren – There is no right or wrong answer here, but parents really need to think through how to allocate their estate when one of their children does not have children of their own or each family has a different number of grandchildren. Is the estate split equally by family? And if giving money directly to grandchildren—does each grandchild receive the same amount, or is the allocation equal by family and a grandchild with no siblings receives more than a grandchild with siblings?
  • Business assets – When parents leave a business to one sibling and equalize other siblings in cash or investments of equal value, one would think they have accomplished peak fairness. Yet some businesses explode after the parents die, making the child that took over the business very wealthy. Alternatively, the business may stumble or even fail, leaving that child in far worse financial situation than their siblings. Either way, the disparity in financial position creates acrimony.
  • Asset in one child’s name – Parents often put assets in a child’s name for probate or tax planning purposes. But as the saying goes, ownership is nine-tenths of the law. Some siblings may depart from the parents’ assumption that they will act just as trustees of that asset for their siblings. They may think of themselves as the actual owner of the asset.
  • No parents, no buffers - One comment from Charles’ book I found truly relevant was “that once the parental referees are out of the picture, the gloves come off.” I have seen this so often. Parents really do act as buffers and referees for their children. Without a referee, disagreements can break out.
  • Spouses and in-laws – Spouses and in-laws in the ear of one child stoking their belief that the parents divided assets unfairly have caused many a sibling fight.


Parents: Have that discussion


Many of the above issues are human nature, which can’t be avoided entirely. But parents need to consider all the above possibilities when drafting a will. Readers of my blog will know that I am a huge proponent of discussing your will to a full or partial extent with your family and explaining your intentions. I think this can sometimes avoid or minimize sibling estate issues.

It is sad that sibling estate fights are even a topic, but they do unfortunately often become an issue. Parents, my suggestion to you is consider these issues, get good estate planning advice, consider a family meeting, and take off your rose-coloured glasses when planning your estate.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.