Vacation property succession planning: Part 2

Vacation Property Succession Planning Part 2: Probate Fees

In Part 1, we focused on minimizing capital gains tax when vacation property succession planning. Another key piece of the planning puzzle is probate fees.

Weighing the options

If your client’s vacation property forms part of her estate on death, it may be subject to probate fees as part of her will. Some clients would benefit from holding title to the vacation property as Joint Tenants with Rights of Survivorship (JTWROS) – note that JTWROS is not available to residents of Quebec. This type of arrangement simplifies estate administration and minimizes probate fees payable by the client’s estate. On the death of the first joint tenant, the property will pass to the surviving tenant(s) by right of survivorship, outside of the first person’s estate. Probate isn’t required to transfer title to this property to the remaining owners, reducing delays and costs.

There are drawbacks to JTWROS ownership. For example, there may be a disposition for tax purposes when the property is transferred into joint tenancy, resulting in a capital gain (or loss) to the transferor. The original owner may also lose full control and decision-making power over the property. As well, the property may be exposed to the personal and business creditor claims of the other joint tenant as well as matrimonial claims.

Read: Pitfalls with the Principal Residence Exemption

Clients in Ontario who are considering holding title to their vacation property as JTWROS should know that under provincial legislation, if a person dies owning an interest in a matrimonial home (such as a vacation property used as a family residence) with a third party who is not her spouse, the joint tenancy will be severed immediately before her death. Her share of the property will not pass to the surviving joint tenant but will form part of her estate and be distributed in accordance with her will or provincial intestacy laws. The property may end up benefiting someone the she didn’t intend, such as her spouse instead of the other joint tenants.

Additionally, caution should always be taken if this approach is being used as a means to promote equality among two children. For example, Suzy has two children, Janet and David, with whom she would like to initiate a JTWROS on her cottage. If Janet dies, the property would remain with Suzy and David, but would not pass to Janet’s children through her estate. In other words, the goal of keeping the asset equal among family members would not be successful, as Janet’s estate wouldn’t receive any interest in the property.

Read: Gen X driving recreational property demand

Another strategy to avoid probate is to transfer the property to a living trust. Assets in a living trust don’t form part of one’s estate. In examining this option with clients, consider:

• Transferring the property to a living trust generally results in a disposition of the property at fair market value, triggering any unrealized gains. The trust is also subject to a deemed disposition of the property at fair market value every 21 years, at which time taxes on any accrued gains must be paid. The 21-year deemed disposition may be avoided by transferring assets to the trust’s beneficiaries before the 21^st anniversary of the trust. If the client is age 65 or older, the property can be transferred into an alter-ego trust (or joint-partner trust for both spouses) on a tax-deferred basis. In this type of trust, the capital gains tax is deferred until the property is sold or the death of the client (or her spouse), whichever occurs first.
• In addition to the taxes that may be payable at the time of setting up this trust, the client also needs to consider the legal and accounting fees that may be incurred in administering this trust.

Read: Make the most of your client’s tax refund

Gifting costs versus benefits

Another option some clients gravitate toward is gifting vacation property during their lifetimes. Gifting the property would eliminate probate fees, as the property would not form part of your estate on death, but the gift itself would trigger capital gains if the property’s value has gone up, as it would be a disposition at fair market value. As discussed in Part 1, one of the first steps should be to perform a cost/benefit analysis. In this approach, ensure clients know what the probate fees are in their jurisdiction. For example, residents of Ontario and B.C. are subject to higher probate fees – up to 1.5% and 1.4% respectively — whereas other provinces such as Alberta and Quebec have minimal to no probate fees.

To better illustrate this, let’s consider the following example:

Tom owns a cottage in Ontario, which he purchased in 2003 for $360,000 and is currently valued at $450,000. He is considering gifting it to his daughter, Emily, this year to avoid the potential future probate fees. Under Ontario probate tax rates ($15 on every $1,000 for estate assets over $50,000), his probate fees would be $6,750 (at today’s value). From a capital gains perspective, gifting the property now would trigger a capital gain of $90,000 ($450,000 – $360,000). Tom’s marginal tax rate is 40%, and given 50% of capital gains are taxable, the capital gains tax would be $18,000.

In this example, while the probate fees are less than Tom’s capital gains tax, this option may still prove advantageous if Tom believes the property value will go up significantly. In that sense, clients would gain two benefits: avoiding probate and eliminating the risk of much larger capital gains taxable to the estate upon death.

Read: Five ways to navigate blended-family finances

Tony Maiorino

Tony Maiorino Vice President and Head, RBC Wealth Planning Services, RBC Wealth Management.