Tax Efficiently Structuring a Real Estate Transaction
I don’t think I’ll ever forget the difference between tenants in common and joint tenants again. I recently had new clients come in asking for advice on how to buy a house with their child. Their questions went like the following:
“We are looking at selling our primary residence and purchasing a house with our son in order to allow him to build up some equity. All three of us would then live in it as our primary residence. He has a child with a former common-law partner and is in the process of signing separation papers. He has not owned a home in the prior 5 years and this would be a way of helping him get ahead. How should we structure the transaction to protect our estate plan? As joint tenants or tenants in common? Would he get access to the first time home buyer land transfer tax? We have three kids and in our will they are all left an equal portion. Will gifting him some money to help buy this house with us effect our estate plan? We heard it can be beneficial for him to be on title to a house so we were thinking 98% him and 1% each to us. Would that eliminate any probate? Would he qualify for the first time home buyers tax credit? Is there also any other tax planning you would recommend?”
After the meeting I started putting together a tax memo to go over all the questions. I thought I would share my memo that outlines the strategy. Their names have obviously been changed to Mom, Dad & Son.
Facts from meeting
Mom and dad currently have their primary residence on the market.
Looking to purchase new house and bring son in as part owner within the next few months.
Would like son to build up some equity in the house over next few years and then use that as a down payment for his future house.
Son has a child with former common-law partner and separation agreement has been signed.
Mom and dad have 3 kids.
Will leaves equal interest to 3 kids on both of their passing.
Issues/Objectives
How best to structure the real estate transaction? Tenants in common or joint tenants?
Will son qualify for first time homebuyers land transfer tax?
Will child qualify for first time homebuyers tax credit?
Is there any other tax planning recommended?
Structuring the transaction
Tenants in common
Occurs when two or more parties own a percentage of the property and don’t have a “right of survivorship” upon death. When a tenant in common dies, their share of the property passes to the estate and the beneficiary/beneficiaries of that estate inherit the interest in the property.
Advantages:
Can hold different percentages of interest if wish to with other owners. For example, 60%, 20% and 20%. Does not have to be equal ownerships.
Can sell their share of property without consent of other owners
Disadvantages:
Subject to probate on the death of any owner of the house
Can be difficult to find a buyer for just a percentage interest
Joint tenants with rights of survivorship (JTWROS)
Each interest of the property must be held equally based on the number of owners and when one party passes there is a “right of survivorship” for remaining owners. The surviving party/parties assume the passing party’s ownership of the property as the deceased person “drops off title” of the house. The property would not fall into the estate and would not require any probate or estate administration tax. Since each owner must have an equal ownership in the property, this would be 33.33% in this case.
Advantages:
Avoids probate, saving money on estate administration taxes.
Transfer to other joint tenants is done very quickly whereas probate can take a long time
Disadvantages:
No longer control the property and cannot refinance any mortgage or sell the property without other owners’ consent.
Child’s interest could be exposed in a division of assets due to separation if put on title.
If child comes into financial trouble, could open up a creditor’s claim on the value of the property.
Option #1 - 1/3 Each as Joint Tenants with Rights of Survivorship
If held as joint tenants, each owner must own an equal share as all the other owners. Therefore, it would be 33.33% each.
Advantages
Upon anyone’s death, their interest would bypass probate and transfer would occur on expedited basis.
Disadvantages
If Mom and dad are first to die, son is left with entire house. Usually, a principal residence forms a large part of an individual’s estate. In this instance, it could have the intended effect of giving more of their estate to son. Son would obtain the house and still have access to 1/3 of remaining estate. This would leave the other children with not enough equalization.
A way to remedy having son take over 100% of house in the event of a demise of mom and dad could be to attach a codicil in the will that states that son’s 1/3 interest is a gift and the remaining 2/3 interests are to be dealt with as the will dictates (divided equally). Then, in the future, if son wishes to sell back his interest and move into another house in a few years the will can be amended again.
Option #2 – 1/3 Interest as Tenants in Common
Each individual would hold their interest and could sell it off if they please.
Advantages
The positive aspect of this structure is that it still forms part of each parent’s estate and can be rolled over to other parent in the event of death. The other parent would then own 66.66% of the house in this event, if will stipulates all assets go to spouse prior to going to all 3 children. Then, if remaining parent were to pass, the 66.66% ownership of house forms part of estate and each child will obtain 1/3 equalization.
Gives parents ability to buy son’s interest back in a few years’ time if he wishes to sell and purchase another house
Disadvantages
Each interest would have to be probated upon death.
Estate would own 66.66% of house if both parents passed and remaining 2 children could possibly force sibling to sell property.
Option #3 – Joint Tenancy as 98%, 1% & 1%
This option is unavailable as joint tenancy must be held in equal interest for each.
Option #4 - Tenants in Common as 98%, 1% & 1%
Son would own 98% of the house with parents owning remaining 2%. The disadvantages are that each interest would have to be probated upon death. Son also has large controlling interest in house and can do whatever he pleases in terms of financing and selling. This option also gives large part of estate to son without taking into consideration equalization of other 2 children. The only real advantage of this option is that son gets ability to build up equity value on day one of transaction and any price appreciation of house as he is gifted vast majority of the equity in the house.
Option # 5 – Mom and dad 100% Owners
Mom and dad own property as JTWROS at 50% each and provide son with gifts to be put into FHSA & RRSP (as seen below). This will allow tax deferred investment growth until such time that the funds are to be ready to purchase a house. Also avoids probate upon death of mom or dad and rolls their ownership over to one or the other. However once both pass, the house will go through probate.
Structure Recommendation
Hold as Joint Tenants WROS for a few years (option #1) as 1/3 each until some equity build up has occurred. If son then wants to use his equity to purchase a different house, parents can buy him out.
If not comfortable giving him 33.33% value of the house on day one, determine a percentage you would like to give and transact using Tenants in Common, even though it will open up probate upon demise of each interest holder.
If not willing for each interest to go through probate upon death (as in option #2), Mom and Dad can purchase 100% of the house as JTWROS and gift son FHSA and RRSP amounts. These can then grow tax-deferred for a couple years until he is ready to purchase house.
Land transfer tax refund for first time homebuyers
Obtaining the land transfer tax refund for first time homebuyers is a one-time thing. If he owned a home at any time prior, he cannot receive the refund. If he didn’t than it will be pro-rated based on his ownership of this new house purchase. To receive it he also must live in this house as his primary residence. This is completed by the lawyer. Due to the fact he owned a house 5 years prior, he will not qualify for this.
First time home buyers tax credit
This tax credit is worth $10,000 and split evenly if purchasing with spouse or common-law partner on a first time house purchase. The individual would have to had not owned a home in the current year or preceding 4 years. Since he has not owned a house in the current year or preceding 4 years, he would be eligible for it on his tax return in the year of purchase. Depending on the interest of house he purchased, that would be the portion of the tax credit that would be put into his tax return.
Other tax planning
First Time Home Savings Account (FHSA)
A FHSA allows an individual who has not 1) owned a home by themselves, 2) jointly owned with spouse or common-law partner or 3) lived in and owned by spouse or common-law partner in the current year or preceding 4 years, to contribute $8,000 per year into a special savings account. Upon contributing, they receive a tax deduction in year of contribution. There is no minimum amount of time that money has to be left in FHSA and therefore can be taken out whenever you wished for house purchase. Parents can gift money to son who can then put it in. Once withdrawn from the account for house purchase, it does not have to be paid back. It also does not affect his RRSP room.
If going to be providing money for his interest in the house, I would gift him the maximum amount in his FHSA for him to contribute, allow him to receive the tax deduction, then withdraw it from the account to pay for the house. This allows him to receive a tax deduction for money that was going to be his when given an interest in the house.
Home Buyers Plan (HBP)
Home buyers plan allows first time home buyers to withdraw from their RRSP, up to $60,000 as of 2024, to be used on a purchase of a home. The definition of a first time home buyer would be if someone did not own a home in the current year or preceding 4 years. Upon withdrawal of this amount for the house purchase, you must start repaying it back the second year after the year of first withdrawal over 15 years. If no repayment is made each year, it will be added into the tax return as income. A FHSA and HBP withdrawal can both be made to purchase a house for the first time.
If son has excess RRSP room, I recommend gifting him $60,000 of the purchase price so he can contribute into his RRSP. He would get a $60,000 tax deduction that could be carried forward if needed while also allowing him to obtain ownership in the house. It would have to sit in his RRSP for at least 90 days, however, before it can be withdrawn for the purchase.
Principle Residence Designation
In the year of sale, Mom and dad must disclose on their T1 personal tax return the total proceeds from sale of principal residence and year it was acquired on form T2091. No taxes are owing from this sale.
Recommendations Summary
Son should immediately open up FHSA to obtain the contribution room available and deposit $8,000 for the tax deduction in current year. In new year make another $8,000 deposit for another tax deduction. This $16,000 can be put toward the house purchase in a few months. Then, contribute $60,000 into son’s RRSP to obtain another tax deduction. He can then withdraw this $60,000 as a Home Buyers Plan to finance the house purchase after held in RRSP for 90 days. This combined (FHSA & HBP) $76,000 contribution would be put towards house purchase while obtaining tax deductions for son.
When purchasing house, hold the house 1/3 each as Joint Tenants WROS with son’s money coming from FHSA and HPB and the remaining amount to get him up to 1/3 as a gift with no tax consequences. By doing this, you are turning a cash gift for a house purchase into a tax deductible gift at same time as letting son build equity in the home. If in a few years son wants to use his equity to purchase a different house, parents can buy him out tax free (as it is son’s principal residence).
In year of purchase son would also obtain first time home buyers tax credit to be reported on T1 depending on the percentage of his purchase.
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