Questions about real estate, family, finances and more

This installment is an extra-long Qualified Advice column, featuring three reader questions and three planners, all members of the Financial Planning Association of Canada, answering. The theme this month is real estate, family and finances—a perennially popular topic in reader questions. 

A MoneySense reader writes:

We’re trying to decide whether to renovate our Ontario cottage as a way to provide a larger inheritance to our two children. We are 60 and 69 and are retired. One of our children owns a house in Toronto, and the other rents in Vancouver. We haven’t provided financial help for a down payment to either. Both kids say they are interested in the cottage to enjoy with their own children.  The cottage is 60 years old and quite small, and we estimate the cost of renovations at $300,000. We own a house worth $900,000, the cottage value is about $450,000 and our investments total about $700,000. For income, we both have defined benefit pensions worth about $120,000 per year combined, plus Canada Pension Plan and Old Age Security.  Our thinking is that by using some of our funds today to invest in the cottage, we’re increasing the value of the cottage our children will inherit, plus helping with capital gains when we die. Does this plan make sense? 

FPAC responds:

Shannon Lee Simmons

You’ve got great pension plans, $700,000 of investable assets and a mortgage-free house. Well done! It sounds like you need a solution that is both financially savvy and emotionally satisfying to feel good about it. If this is strictly about helping your kids, you could give them the planned amount now as an early inheritance–but it sounds like building a family experience with the cottage is important. It’s not just about inheritance. Assuming you’d like to proceed with the cottage renovations, there are four potential sources of funds: 

• Withdrawing from a registered retirement savings plan (RRSP): Given your existing income, this is likely an expensive option tax-wise, and it might also cause some of your Old Age Security (OAS) to be clawed back
• Withdrawing from a tax-free savings account (TFSA): No tax implications, but you’re unlikely to have all required funds available from TFSAs
• Withdrawing from non-registered investment accounts: You’d need to report and pay tax on any capital gains
• Taking a mortgage on your principal residence: As interest rates are so low, this option may make the most make sense–but you need to budget the new monthly repayments  

Whether you pull money from registered or non-registered investments or take on a mortgage, you should definitely get some customized advice from a Certified Financial Planner.  If we can assume that you can absolutely afford to do this, then yes, investing the $300,000 into the cottage will increase your adjusted cost base (ACB) of the property. The higher the ACB, the lower the capital gain when you pass away and therefore the lower the taxes to be paid by the estate. Make sure you’re keeping track of all major repairs and improvements over the years. Keep in mind that recently, cottage property values have been skyrocketing in Ontario, so if this trend continues, your estate may face a large capital gain even if you put money into renovations. A life insurance policy could be used to cover off the potential tax bill, but at a cost.

Zak Smith

It sounds like the renovations would create the space for you, your children and grandchildren to find a lot of enjoyment at the cottage now and in the future. And isn’t that why we build wealth—to create these environments, experiences and memories to share with the ones we love. That said, life changes! So here are a few questions you may want to factor into your decision: 

• Will your B.C. child always be able to justify/afford these cross-country trips as their family potentially grows? 
• Should you choose to subsidize some of the costs to bring your B.C. child’s family to the cottage, is there potential for conflict with your Toronto-based child? 
• If you chose to assist your B.C. child, would you plan to equalize in some way your Toronto-based child’s family—and could your finances sustain providing this assistance while continuing to support your own needs? 
• Will you always want to make the commute to the cottage yourselves? 
• And finally, would your children appreciate your generosity more through assistance with their own home purchase or home upgrades, assisting with the grandkids’ education, or more variety on your family trips?

My suggestion: Have a discussion with the family to help make the decision that you see bringing the most happiness to you and to them in the foreseeable future, with the least probability of conflict. Whatever your decision, if things change and it no longer brings the joy it does now, there is always the opportunity to consider selling the property down the road.

A MoneySense reader writes:

We have several properties, and I would like to add the name of one of our kids to each property. That way, when we pass on, each kid has a property in their own name.  Can you please comment on this plan, including the tax implications? What would happen if one of our kids got divorced?

FPAC responds:

Michael Deepwell

Adding your kids on title to your properties may be a simple act and convenient. But it has significant—and potentially costly—consequences. It is unclear what type of joint ownership you’re actually considering. Here are the options: 

• Joint tenants with right of survivorship: Ownership passes to the last living person
• Co-ownership or “tenants in common”: Each owner has an ownership percentage, whether 50/50 or another split, which passes to their estate upon their death
• Trust ownership: The property is held in trust on behalf of the parents’ estate

In 2007, the Supreme Court of Canada established a new form of ownership in the Pecore decision. That decision found that gifts to adult children are presumed to be held in a “resulting trust” for the parent’s estate, unless clear evidence can be shown otherwise. In cases where there is a resulting trust, the transferred property would be administered and dealt with by the will, if there is one. Or, if there is no valid will, it’s dealt with by the intestacy rules in the province where the property is located. It’s recommended to talk to an estate lawyer before proceeding. The legal form of joint ownership aside, the Canada Revenue Agency (CRA) may consider the transfer into joint ownership with the children as a deemed disposition of the property, triggering recognition of a potential capital gain unless the principal residence exemption can be used to partially or fully offset the gain. Property transfer tax may also be required to be paid, depending on the usage of the property and province it’s located in.  If the property is held in co-ownership or with the right of survivorship, it may also be exposed to their creditors or to the division of matrimonial property (if the child is legally married) or claims by a common-law partner upon the breakdown of your child’s relationship. Where property is held in trust, it may be excluded. As you can see, there can be considerable legal and tax complexity when you put a child’s name on a property you own. There are also other issues to consider. For example, I’ll assume you have one property for each child, but that may not be the case when you die—what would happen if you are forced to sell a property to raise funds for medical or long-term care? How would you decide which property to sell, and how your kids would be impacted as a result?  In summary, putting your kids on the title of property you own can seem like an attractive way to help them build wealth, but it can lead to unintended financial and other consequences. You’d be wise to consider other ways of helping your children financially, and to get professional advice from a qualified provider to help you sort through your options. 

A MoneySense reader writes:

We own a townhouse that we lived in for years. When my mother moved to our city, we bought a new home and started renting the townhouse to her.  For the past four years, she’s been renting below market value, paying about $500 less than what we could be renting it for to strangers. We have been claiming the rental income on our tax returns, not realizing that we didn’t have to. Now we are hoping to sell the townhouse.  I have two questions: 

• Is there anything we can do retroactively about the rental income we claimed?
• More importantly, is there any positive impact on capital gains tax that we have only ever rented the house to a family member at below fair market value?

FPAC responds:

Zak Smith

First of all, it is important to define the nature of the rental income you have been claiming on your tax return.  Under normal circumstances, if you are renting to a “stranger” at fair market value and your eligible rental expenses amount to more than your rental income, you would then have a rental loss that could be used as a deduction against other taxable income. If the total of these eligible expenses is equal to or greater than the rent you charged, you would not have any taxable income from renting.  However, in your case, because you are renting for an amount below fair market value, you will not be able to claim a rental loss. If the amount you reported as income only represents the amount that you charged your mother for rent, then you have foregone claiming rental expenses. 

Michael Deepwell

The Income Tax Act requires you to report income collected from rental activities conducted with sufficient commercial activities. The market value, rather than the actual amount received, is the amount to report on your tax return. So, although you are renting about $500 below market value and not receiving this as income, for tax purposes it is considered income. If you had not collected any rental income it could be a different story. However, this is in hindsight, so the value of proactive planning from a qualified tax professional has passed. The CRA also does not allow retroactive tax planning. While I haven’t reviewed the specifics on your filed tax returns, I suspect you will not be able to retroactively make adjustments that result in lower taxes, including increasing or beginning to claim capital cost allowance (a deduction that is claimed on depreciable assets). When you sell the townhouse, you will recognize the capital gain—or loss—on the sale for the difference between the original value and the selling price. The amount you are required to report will be affected by whether you made a “change of use” election (also known as a section 45(2) election) when you started renting to your mom, and whether you claimed any capital cost allowance. You mentioned you lived in the townhouse before renting to your mom. As a result, there was a “change in use” when you moved out, and the property was turned into a rental property for your mom. This change is considered a deemed disposition for tax purposes—that is, the property is considered to have been sold and immediately repurchased at fair market value, even when no legal transaction has actually occurred.  The deemed disposition marks the end of a period (in this case, personal usage) and the beginning of another period, triggering the determination of any capital gain or loss. Based on what you’ve written, I suspect no determination was made when your mom started renting, although the property changed from personal use to a rental use. A section 45(2) election would have potentially allowed you to opt out of the change of use provisions, deferring the recognition of any capital gain to a later year so long as certain other conditions were met.  If you did not file a section 45(2) election, some adjustments may be necessary for prior years. As such, it would be advisable to use a qualified tax professional in the year of sale for the townhouse to sort out the specifics. They will also be able to determine which property to allocate the principal residence exemption for the overlapping periods of ownership of the townhouse and new home. A portion of the capital gain on the sale of the townhouse may be exempt if you meet the conditions to claim the Principal Residence Exemption. A professional could also help determine whether it makes sense to file a section 45(2) election now, despite the late-filing fines you would face. 

These responses were provided by FPAC members Shannon Lee Simmons, the founder of The New School of Finance and author of Worry-Free Money; Michael Deepwell, TEP, CPA, CA, CFP, CLU, of accounting and advice-only financial planning firm Lamp Financial; and Zak Smith, CA, CPA, CFP, CLU and Associate Wealth Planner at McMillan Wealth Solutions with Richardson Wealth. Qualified Advice is written by members of FPAC (the Financial Planning Association of Canada), a MoneySense content partner. Working closely with governments, regulators, financial planners, academia, vendors and the general public, FPAC’s goal is to set standards and principles that will allow financial planning to evolve into a knowledge-based profession which ultimately commands the credibility, public awareness and respect afforded to other advisory professions.
If you have financial planning questions, FPAC members can help—consult our directory of members to find the right fit for you. 

More on financial advice:

• The MoneySense Find a Qualified Advisor Tool
• Using The Wealth Formula to boost investment success
• How does a spousal RRSP withdrawal work?

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson Wealth Limited or its affiliates. Richardson Wealth Limited is a member of Canadian Investor Protection Fund. Richardson Wealth is a trademark of James Richardson & Sons, Limited used under license.