When trying to save on taxes in the future, people often make estate planning mistakes. Many of us know someone who had their house or bank accounts owned jointly with a spouse. The joint property of the deceased would generally be passed on to the surviving spouse without immediate income tax consequences or Estate Administration Tax (“EAT”, formerly known as probate). Beneficiaries, who are usually the children of the surviving spouse, often worry about the amount of the ETA they may have to pay upon the death of the second parent.
In Ontario, the EAT is calculated as 1.5% of the value of the estate over $50,000. The EAT, for example, on a $1,000,000 home would be $15,000, if for simplicity we ignore the $50,000 threshold.
This is where we often see parents entering into a joint ownership with an adult child to avoid the Estate Administration Tax. This could be the worst mistake for your estate plan! Not only it may not avoid probate after all, but it could also end up costing the family a lot more than 1.5% of potential savings.
The confusion about saving on EAT comes from the Estate Information Return itself, which is used by the executors to provide information about the deceased to the Ministry of Finance. After all, for the purpose of calculating the value of the assets, the document says: “If assets pass outside of the estate, do not include them in the calculation of value of the estate, e.g., do not include assets which were jointly owned with a right of survivorship.”
This seems like a crystal-clear explanation of what assets do not need to be included for the purpose of calculating the EAT. There is another section (called Beneficial Interests) that is often disregarded by beneficiaries and non-professional executors because of its technical nature. It states: “Remember to include all property in which the deceased had a beneficial interest, even if the deceased did not hold legal title and legal title was held in another person’s name.”
What is the difference between beneficial interest and legal title?
It is important to provide a distinction between beneficial interest and legal title, as the separation of the two is at the heart of the matter.
All property ownership could be divided into legal and beneficial ownership. In many cases legal owners are also beneficial owners. An example would be someone who owns and lives in their house. A beneficial owner, however, may be different from a legal owner. A deposit made by a client to a lawyer’s trust account, for example, would separate the ownership. In this case, the law firm would be the legal owner of the property, while the client would be the beneficial owner. The law firm cannot touch these funds without express directions from their client.
What is important to consider when a parent decides to transfer a property to an adult child is: is the parent transferring only the legal ownership or a beneficial ownership as well? In many cases, it is only the legal ownership that gets transferred to avoid the EAT. The parent rarely would want the child to have immediate access to 50% of investment assets, for example, for their personal use. Why would not make an outright gift instead?
Now you can see the significance of the Beneficial Interest section of the Estate Information Return.
What are some other pitfalls of joint ownership with an adult child?
There are a number of potential negative consequences that should be considered before any change of ownership. The following discussion is limited to real estate and assets held in nonregistered accounts. This is not an exhaustive list. Each situation is different, so any outcome will depend on specific factors of each case.
- Property may become available to the creditors of the new joint owner. Creditors could include CRA, in case of any unpaid tax obligations.
- The original owner may not be able to make changes to the account without obtaining consent of the new joint owner;
- A joint owner could sever the asset into independent shares (i.e., tenants in common) without knowledge or consent of the original owner;
- A joint owner may have to pay tax on their portion of future investment or rental income;
- A portion of the assets in a joint account may be subject to a deemed disposition for tax purposes;
- The original owner may not be able to claim the principal residence exemption on the entire property;
- Family members or other beneficiaries of the estate (e.g., charities) may dispute the asset distribution through the joint ownership arrangement;
- The estate may not have sufficient liquidity to pay debt and taxes if most of the assets transfer outside of the estate. Income tax on RRIF accounts, for example, have to be paid by the estate, while the entire RRIF account balance will be transferred to the RRIF beneficiary/ies.
Contact Geoff Pollock & Associates regarding your estate planning
We will be happy to discuss your specific situation, and how a joint ownership may impact your estate plan. Other strategies may also be available to facilitate objectives, such as use of power of attorney for property. You can give us a call at +1 (416) 777-0088 or contact us via website: https://geoffpollock.com.