Avoiding mistakes in your estate planning could save you hundreds of thousands of dollars in taxes and years of expensive lawsuits. If you own and invest in apartment buildings, you need to know about these Five Things Nobody Told You About Wills.
In this article, we’ll take landlords Betty and Jim as an example. Betty and Jim have lived in the same home in Burnaby since they got married in the 1960s. They raised their three children, Ray, Julie and Dave, who now all have their own families. Jim’s plumbing business took off in the 1970s.
In 1985, Jim’s company got hired to replace the pipes in an older apartment building. Jim found out that the building was for sale, and with the money he had saved over the years, decided to buy it.
Over time, the couple acquired another, smaller building as well. They hired their son Dave to manage this smaller building in the mid-90s. Unfortunately, for the next two years they heard nothing but complaints from suppliers and tenants about Dave’s management abilities. They had to fire Dave – and Dave didn’t take it well.
After a series of arguments over the next few months, Dave moved across the country and they haven’t heard from him since. On the other hand, their other children Ray and Julie have remained very close to Betty and Jim.
Unfortunately, Jim passed away after a long battle with cancer last year. Luckily, they had received good estate planning advice years before, and all their assets transferred by joint tenancies and beneficiary designations to Betty. But Betty now has a problem, what does she do next?
Hopefully Betty will avoid these five disastrous mistakes:
1. Joint Tenancies with Kids
When a husband and wife own a piece of real estate together, it is usually registered in joint tenancy.
That was the case in our example – so when Jim died, the home and the apartment buildings all transferred directly to Betty without the time and expense of having to go through probate. The probate process takes between 1 and 2 years to complete and during the process, the government
charges roughly 1.4% of the total value of the assets that that person owned.
Understandably, most people want to avoid this if possible. Betty heard this from a friend, and now thinks: “now that Jim is gone, I’ll put my son Ray on title to all the properties as a joint tenant and they will all transfer to him when I die and avoid that mess that they call probate.”
There are four potentially huge problems with putting a child as joint tenant on a property:
(a) Pay Too Many Taxes
If Betty adds Ray as joint owner of her home, because Ray doesn’t live there, the home loses the half of the “Principal Residence Exemption” for tax purposes. Generally speaking, when you sell a piece of real estate, you have to pay tax on the capital gain (profit) that you made.
One exception to this generally is if you have lived in a property the entire time you’ve owned it, you’re exempt from this capital gains tax. So, if Betty keeps the property in her own name, when she dies or sells it, she won’t have to pay taxes on it. Ray lives in another house though.
So if he is added as half owner of the house, half of this exception disappears. Betty and Jim bought the house in the 1960s for $40,000, and it’s now worth $1.9 million. Part of this huge profit would be taxable if Ray were to be added to title, and this over time could amount to hundreds of thousands of dollars.
(b) Liable to Kid’s Creditors
Ray appears to be successful in Betty’s eyes. What she doesn’t know is that Ray’s dry cleaning business is now being sued for millions of dollars of environmental damage due years of his dry cleaning fluids leeching into the soil beneath the store.
Ray’s creditors could seize Ray’s share of the house and apartment buildings if he is added as half owner. Also true with Ray’s wife Mary. If their relationship ever ended in a separation, she would have a claim to the house and apartment buildings if Ray was part owner.
(c) It’s Too Late to Take the Kids Off Title
Betty and her son Ray’s relationship is currently great. But if their relationship turned sour in the future, Betty could not take back those gifts of half the properties to Ray.
(d) Extra Confusion & Potential Lawsuits
Betty’s Will says everything is to be divided equally between her children Ray and Julie. But because Ray was given the property in joint tenancy, he might argue that Betty intended for all the property to pass to him by right of survivorship, just like it did to his mom when his dad died. Julie may have a good claim to the property though, as it depends on Betty’s intent at the time of the transfer to Ray – did she intend for him to inherit it all, or did she want Ray to distribute it according to the will?
These types of disputes play out in courtrooms across Canada every day, and could cost hundreds of thousands of dollars to the family, not to mention the irreparable damage to Ray and Julie’s relationship.
2. Internet Wills
Betty considers drafting a new will, since her husband is no longer alive. She calls around and finds that the cost of a fairly basic will with a lawyer can range anywhere from $300 to $1,000.
Her friend tells her that there are far cheaper solutions like do-it- yourself wills found on the internet or at drugstores. These wills are scary. Most are made in the United States. If you happen to find one made in Canada, it’s likely to be from Ontario. These places have different laws than BC.
Even if Betty finds a Will that says it’s made in BC, there are usually flaws, either in the template itself or the fill-in- the-blank portions. To fix these flaws, executors have to pay anywhere from a couple hundred to tens of thousands of dollars in legal fees – if they are fixable at all.
3. Wills Variation
If Betty opts for getting no legal advice with a do-it- yourself template, she may not realize that there could be problems with disinheriting her estranged son Dave. After someone dies in BC, children and spouses have the right to contest the terms of their will in the Supreme Court.
Such disputes tear families apart and frequently cost well over $10,000. With proper planning and advice, Betty can lessen Dave’s chances of succeeding in such a claim.
4. Not Minimizing Taxes
If you are worth over two million dollars like Betty, you should be consulting with professionals about your tax-saving estate planning options. With a bit of paperwork and a few thousand in legal and accounting fees, you can save tens or even hundreds of thousands on future taxes.
But only if you plan in advance. Most strategies involve using trusts which can avoid the probate fee and in some cases, allow for income splitting to save on taxes. Without planning in advance with qualified professionals, Betty stands to lose out on these savings.
5. Improper Tax Planning
Assets such as Tax Free Savings Accounts, pensions, life insurance policies, RRSPs, and RRIFs allow you to designate a beneficiary to pay to when you pass away. This avoids the probate process and fee, so is generally a good idea. Betty’s house (worth $1.9 M), and sizable RRIFs (worth $1M) are worth the about same amount as her smaller apartment building (worth $3M).
She has no other sizable assets. She plans to sell the larger apartment building next year and
give the proceeds to charity. She wants to give the smaller apartment building to Ray in her will when she dies. So to balance it out, she designates Julie as the beneficiary of the RRIFs and gives Julie the house in the will. Sounds simple enough. But this plan is riddled with tax problems.
Here’s what will happen in Betty’s final tax return (filed after her death): there will be no tax payable on her house; the full value of her RRIFs is included as taxable income; and half the value of the profit (capital gain) she’s made off of the rise in value of the apartment is included as taxable income. Her will says that the tax on her RRIF and the apartment building will be paid by her estate, which is common.
The problem is that Julie may end up receiving the money from the RRIFs tax free while Betty’s estate pays the taxes on them. But before Ray can receive the apartment building through Betty’s will, the executor has to pay all the taxes. These amount to roughly $450,000 for the RRIFs and $520,000 for the apartment building (since they bought it in 1996 for about $750,000).
Because the estate pays the tax for the RRIFs that went to Julie, Ray ends up with much less than her. Equally problematic is that the original plan of Betty giving Ray the apartment building and giving Julie the house likely wouldn’t be fulfilled as one or both of the properties would need to be sold to pay the $970,000 in taxes.
Extreme care should be taken when designating someone as beneficiary of RRSPs or RRIFs and when giving property with a large capital gain.
Proper planning including professional advice should help Betty avoid all of these estate planning traps and allow her to pass her assets to her family with the least amount of expense and disputes. You too can avoid extra tax and family disputes by avoiding these 5 disastrous estate planning mistakes.
About the Authors:
Mike Beishuizen is the Founder of Westcoast Wills & Estates (www.westcoastwills.com). A practicing lawyer, Mike is a member of the Law Society of British Columbia and the Canadian Bar Association’s Wills & Trusts and Elder Law subsections. Mike is available at [email protected] and (604) 230-1068.
Seth Baker is the Managing Broker and Owner of Multifamily Real Estate Services (www.multifamily.ca). A deal-maker, Seth is dedicated to providing value for investors buying and selling apartment buildings. Seth is available at [email protected] and (778) 235-9293.