How best to structure your real estate investment?

Let’s explore a scenario: A number of years ago you took advantage of a great opportunity and purchased real estate at a great price. Today, with increasing rents and market growth, your equity value has increased tremendously.

At that time, you moved quickly and everything is in your name or you put it into a holding company, or worse still, you used your operating business to purchase. Now at 55 years of age or older, you are thinking about the future. What if something happens to you? What if you wanted to leave the real estate to your children or grandchildren?

Many considerations

It’s a lot to consider. In Canada, there is a deemed disposition on death, and unless you have a spouse (this delays things until their death), there will be a deemed capital gain on the difference between the adjusted cost base (purchase price plus money put in) and current value. This means the kids will need to find the funds to pay the tax, and may be forced to sell the asset to deal with the tax. This is an unfortunate end when your wishes were to keep the property and have it generate money for the family.

What if it’s in a holding company where you own the shares? Same result on the share value, and worse because it can lead to double taxation. There is a deemed disposition of the shares of Holdco on death, however, Holdco does not have a deemed disposition of the assets in it. You might end up having to plan and mitigate the tax through proper estate planning (such as pipeline planning, loss carry-back planning and life insurance).
The big question is: What to do? Can it all be reorganized to provide the most tax effective and protective result? The answer is yes. It will not be as perfect as doing it properly the first time, but you can certainly limit your exposure on all fronts.

The interesting piece is that for those who are looking to invest, a lot of the same principles will apply to save you grief later.

Trusted professionals

The first thing you need to do is speak to your accountant and find out if they have a knowledgeable tax department capable of sophisticated tax planning, and the same applies to your lawyer. If your accountants have these services, find out why they have not discussed this with you before being prompted. Your trusted professionals should be proactive.

Here’s an example that will give you an idea of what can be done with the right support.

Patrick is 55 years old and married to Sherri, with three children all over 18 years of age. When he was 30, he purchased, in his own name, a plaza in Richmond Hill. For the last 25 years, he has been paying down the mortgage and increasing the rent he charges tenants. The building has been well maintained and has increased in value by $4 million. He worries what will happen in the event of his death, and has sought professional help to reorganize his affairs.

The first thing that will happen is that there should be a thorough review of all of Patrick’s affairs, and then a plan will evolve. This might include using Section 85 of the Income Tax Act to transfer Patrick’s Plaza to a holding company (“Holdco”) on a tax-free basis. In that scenario, when the dust settles, Patrick would own a special kind of share in Holdco that has a frozen value, and perhaps a family trust would own the common shares. What this does in its most simple form, it allows Holdco to redeem a percentage of Patrick’s special shares annually. The more that are redeemed, the less tax will be payable on Patrick’s death. In the meantime, the future gain is accruing to the benefit of the trust and its beneficiaries.

Practical advice

As noted above, contemporaneously with the “freeze,” you might consider that a discretionary family trust be established with Patrick and Sherri as trustees, with both of them, all the children, future descendants and certain corporations, as discretionary beneficiaries.

Tax and succession planning for real estate investments requires integrating professionals who are knowledgeable and capable of providing practical advice tailored to the situation. It’s better to start properly, in order that you will save money in the future. Planning is everything.