It is often said it is better to give than to receive— and it's no exception when it comes to offering a gift in the form of real estate. In fact, according to Toronto law firm Grimhaus, gifting real estate is tax deductible. Before you get too excited, be aware that, as is the case in every legal situation, there is fine print. Not every single gift is tax deductible, nor will the giftee—whether that is your adult child, a spouse or common law partner, or a qualifying spousal trust—necessarily receive capital gain or loss. There is no "gift tax" in Ontario, but income tax laws make it possible for you to incur unfortunate tax consequences nonetheless.
By and large, gifting property is a positive thing for all parties. Historical properties with official certification, donations to registered charities, and farms are all taxable due to the social, ecological, and cultural benefits they provide at local and provincial levels.
There are personal benefits, too. Parents or grandparents who wish to preserve the familial history of their home and pass it along to their kids or grandkids ensure that their legacy lives on and provide a place for many generations to live in comfort. In the current housing market, many millennials are grateful for their elders’ insistence on keeping it in the family.
The main benefit of gifting is that it saves your heirs punishing capital gains taxes on inheritance.
However, no situation is exactly the same. Depending on who or what you are gifting, your tax consequences may be different. Let's have a look at a couple of those situations.
Adjusted Cost Base
Whenever a property is gifted, capital gains and losses are calculated using a standard known as the Adjusted Cost Base. The calculation is fairly simple: the value that the item has been sold for minus the original price you paid for it. Then you divide that number by two and that's the amount from which you are supposed to pay the tax. But if you're gifting a property, you're not really selling it, right? If you're confused, don't worry.
Gifting real estate to any family member, be they a blood relative, adopted child, or spouse, is technically considered a sale on paper. Not only that, but it is considered a sale at the property's fair market value. This means that if your giftee is given a property that has drastically depreciated in value, you'll both find yourself at an advantage: they will have gained a valuable asset, and you can gain fairly large tax credit.
However, the receiver of the gift is also at risk of incurring tax consequences should they ever sell the property. Even though they paid nothing for the property in the first place, they are legally considered to have acquired the property at the fair market value. Is it even a good idea to gift property if you are only going to force unpleasant tax consequences on your relative or spouse?
To avoid taxes, the surest path would be to sell quickly. If they sell the home before the value changes, the recipient will avoid any tax consequences and enjoy all the money. That's because the the capital gain is only calculated from the point of receiving the gift to the point of closing a sale.
If the giftee already owned the property for some time, any large capital gains shouldn't be an issue as s/he will only have to pay the taxes on capital gains when selling. S/he should just calculate capital gains into the asset value when considering their overall financial position. Selling the asset with capital gains in a year where s/he sells assets with capital losses (a bad investment) would be one way to reduce the tax burden at no cost to the giftee. If at the time of gifting full market value is assessed that also lightens the giftee's burden, probably not at the expense of the gifter (except in markets like Toronto or Vancouver with very high real estate prices over the $750K threshold for a primary residence).
Gifting a principal residence
If the property you’re offering up is your principal residence, most of the gifting will be exempt from capital gains tax. How much you’ll incur will depend on the length of time it was your principal residence. If the property was your principal residence for the entirety of ownership, you are considered in luck, since there are no capital gain taxes for this situation. If the property became a principal residence later, you count all the years it was your principal residence times your capital gain. If you divide that number by number of years you owned the residence, that is your capital gain in this situation.
For example, a person owns a home for 20 years. However it's their principal residence only for 10 years. The property appreciated in value by $100,000 since their bought it fifteen years ago.
(10 x $100,000) / 20 = $50,000
Their capital gain in this situation is considered $50,000. Which makes $25,000 taxable under a current law (about 43 per cent tax applicable).
If the home is also the giftee’s principal residence, such as your adult child or dependent who grew up there, they will also likely be able to avoid capital gains taxes.
The requirements for qualification principal residency are fairly straightforward: you, your spouse or common-law partner, and any dependents must have "ordinarily inhabited" the property in each year you claimed it as your principal residence. Many retirees run into issues with this due to very specific loopholes. If you spend years as a snowbird in a Florida retirement community, you’ve probably unknowingly given up principal residency of your Canadian property.
Be very careful with residency if you own a valuable primary residence in Canada and have heirs whose financial well-being is of concern to you.
Difference between gifting and inheritance
In many ways, gifting and inheritance are similar acts, but there are some crucial differences. The Globe and Mail article again reports that it is common for parents to transfer 50 per cent ownership to their children. But the Canada Revenue Agency views these "transfers" as partial sales, rather than gifts. If the adult child has a principal residence of their own, they will be heavily taxed—up to 50 per cent—on any future increase in value on their parents’ home.
Gifting a property that hasn't appreciated in value, before or after death, does not incur such serious tax consequences. The Financial Post reports positively on this new trend in estate planning: giving away assets such as real estate prior to death can provide overall tax benefits to both the homeowner and the giftee, because it's considered to be an inheritance rather than a gift, especially if your adult children have not amassed any debt, and will be taxed at a lower rate than you would be if the home continued to exist in your name.
Though tax benefits and downfalls will vary widely depending on your income, the Financial Post offers an example of one Ontarian who amassed substantial wealth during their lifetime and is in the highest tax bracket: a child with no income who has been gifted a property taxed heavily (due to their parent’s high income) can expect to see up to $132,000 of the income taxed at the child’s graduated rates. It’s easy to see why this would be beneficial for both parties hoping to avoid extremely high income tax.
Coming back to the difference between inheritance and gifting, the main glaring difference is that inheritance can set up people up for a nasty shock when they also inherit your income tax. TurboTax explains that the Canada Revenue Agency instead treats the inheritance as a sale, unless the estate is inherited by a surviving spouse or common law partner.
If the estate is instead inherited by an adult child, grandchild, or other relatives, the deceased homeowner is considered to have received the fair market value of his or her registered assets, such as RRSPs, before death. Thus, all income earned by the deceased homeowner is both taxed on a final return and taxed by inheritance tax. This double taxation is completely avoided by gifting in your lifetime.
For real tax advantage, the giftee should at least on paper make that property his or her primary residence if s/he doesn't own an existing primary residence. This might mean selling off a starter flat or turning it into a theoretical investment property (non-primary residence). Consult carefully with a tax lawyer on what the exact boundaries are for migrating primary residency to make sure Revenue Canada won't be able to claim back your tax savings.
Gifting property with a mortgage
There are a variety of reasons why a parent may wish to gift a home with an existing mortgage liability to their adult child, especially in the current economic climate, wherein many millennials are finding it difficult to qualify for mortgages of their own.
Many Canadians are uncertain if it is even possible to gift a house with a mortgage, but the good news is that, with a little creativity, there are ways in which it is.
You might consider refinancing your existing mortgage and adding your child as a co-signer. This way you both have a financial responsibility for the mortgage. Your mortgage company will have to approve the gift before it can be done— and if your child cannot qualify for a partial mortgage on their own, they will not be approved. Mortgage companies will not be willing to take this sort of risk.
Another way where the giftee can avoid qualifying for a mortgage altogether is selling your home to your kids through an all-inclusive trust deed (AITD), which will keep the mortgage in your name but the ownership of the house in theirs. AITD basically involves wrapping your existing mortgage with another subordinate mortgage. You children will have the obligation to pay you an assortment of monthly payments that are corresponding or higher than your monthly mortgage payments and get the property in return.
Co-ownership between parents and adult children is another increasingly popular option for parents. Some families choose this option so that they can continue to live together, with the adult children or grandchildren under the same roof, while others are motivated solely by the desire to secure a mortgage for their kids and allow them to live independently in the rising Canadian housing market.
Since familial relations are slightly different and more emotionally tinged than those you might form with a banker or lender, it is important to spell out the details to your adult children and settle on a strategy that works well for all of you. Along with legal documentation that comes along with the mortgage agreement, it is advisable for parents and children to solidly document—in clear and concise writing—what their expectations are.
Timing your gift
Co-ownership does not offer the same tax advantages which gifting does. The child will have tax free primary residence capital gains on his or her share but will pay full capital gains and inheritance on the parents' share when they pass away. Gifting is a tax loophole which will probably be closed by the government within two years now that it's out in the open. If you want to take full advantage of the gifting tax benefits available, now is the time. As King Lear discovered at his peril, when gifting one must have reason to trust your children.