The recent announcement from the Federal Government regarding an increase in the capital gains inclusion rate for individuals, trusts, and corporations has sparked significant discussion. This policy change will likely have widespread implications for asset management strategies. One area of particular interest is the creation of family trusts in Ontario to hold real property. While family trusts can offer numerous advantages, including estate planning, tax benefits, and asset protection, they also come with certain disadvantages such as complexity and costs. Understanding the full scope of these pros and cons is crucial for families considering this financial strategy in the new tax landscape.
Advantages
Estate Planning and Control:
- Asset Protection: A family trust can protect property from creditors or beneficiaries’ potential financial issues.
- Avoidance of an Application for Certificate of Appointment (aka Probate Application): Transferring property into a trust can help avoid the probate process upon the settlor’s death, reducing delays and probate fees.
- Continued Management: The trust can provide continuous management of the property if the settlor becomes incapacitated or dies.
Tax Planning:
- Income Splitting: Potential for income splitting among beneficiaries, which can result in tax savings.
- Capital Gains Tax Deferral: Trusts can sometimes defer capital gains taxes, though this is subject to complex rules and must be carefully managed.
Privacy:
- Confidentiality: Trusts are private arrangements and do not become public records, unlike wills, which can become public during probate.
Flexibility:
- Tailored Beneficiary Provisions: Trusts can specify detailed instructions on how the property should be managed and distributed, accommodating various family needs and circumstances.
Succession Planning:
- Smooth Transition: Helps ensure a smooth transition of property ownership and management across generations.
Disadvantages
Costs:
- Setup and Maintenance: Establishing a trust involves legal fees, and ongoing administrative costs can be significant.
- Tax Filing: Trusts have their own tax filing requirements, which adds to the complexity and cost.
Complexity:
- Administrative Burden: Managing a trust requires ongoing attention to legal and tax obligations, which can be burdensome.
- Regulatory Compliance: Trustees must comply with fiduciary duties and trust laws, which can be complex and demanding.
Loss of Control:
- Transfer of Ownership: Once property is transferred to a trust, the original owner (settlor) loses direct control over it, which might be a drawback for some individuals.
Potential Tax Implications:
- Attribution Rules: Income generated by the trust property might be attributed back to the settlor under certain circumstances, potentially negating tax benefits.
- 21-Year Rule: Trusts in Canada face a deemed disposition every 21 years, potentially triggering capital gains tax unless proper planning is in place.
Changing Laws:
- Regulatory Changes: Future changes in tax laws or trust regulations could impact the benefits and operations of the trust.
Family Dynamics:
- Potential Conflicts: Trusts can sometimes lead to disputes among beneficiaries or between trustees and beneficiaries, especially if terms are not clear or perceived as unfair.
Food for Thought: should I act before June 25, 2024?
The change in the capital gains inclusion rate will impact both individuals and entities (corporations and trusts), resulting in higher taxes on capital gains. However, taxpayers should be aware of potential unforeseen tax consequences that might outweigh the benefits of realizing a gain before the inclusion rate increase. Consider the following points:
- Large capital gains may result in alternative minimum tax for individuals and certain trusts.
- Gains on a Canadian residential property (or rights to a pre-construction residential property) held for less than one year may be deemed to be business income (i.e., 100% taxable) under the residential property flipping rule, unless an exception is met.
- The proposed general anti-avoidance rule (GAAR) and penalty.
- Additional factors, such as current market prices and the loss of the tax-deferral on the unrealized gain.
Creating a family trust to hold real property in Ontario can offer significant benefits in terms of estate planning, asset protection, and tax management. However, it also comes with considerable costs, administrative complexity, and potential legal and tax challenges. Careful consideration and professional advice are essential to determine if this option aligns with the family’s goals and circumstances.
This blog post was written by Diana Tebby, a member of the Real Estate and Wills and Estates teams. She can be reached at 613-369-0384 or at diana.tebby@mannlawyers.com.
