Taxes alone should not be the driver of important financial decisions:

Recently tabled federal government legislation entitled Fairness for Every Generation became a source of stress for many Canadians, especially those with second homes they are in the process of selling.

As reported the other day in The Globe and Mail: “Cottage owners looking to sell are scrambling to close deals before proposed changes to the rules on capital gains take effect and potentially leave them on the hook for much higher tax bills.”

Although the new federal budget legislation has serious implications for second home ownership, its applications extend significantly beyond real estate.

The law of unintended consequences

What this new piece of legislation highlights is the law of unintended consequences. The unintended consequence of this new bill is that it casts a penetrating light on an often-unappreciated aspect of wealth management – namely disciplined and timely estate and trust planning.

Consistent with our philosophy of reverse engineering complex problems, which is a fancy way of describing a process which starts at the end and works back to the beginning, we prefer to treat this forthcoming piece of legislation as an opportunity rather than a threat.

Budget specifics: 50% to 66.67%

Let’s review the proposed legislation in detail. As Scotia Wealth Management (SWM) explains: “Currently, 50% of a capital gain is included in calculating a taxpayer’s income. This is referred to as the capital gains inclusion rate. The 50% inclusion rate also applies to capital losses.

The 2024 Budget proposes to increase the capital gains inclusion rate from 50% to 66.67% for corporations and trusts, and from 50% to 66.67% on the portion of capital gains realised in the year that exceed $250,000 for individuals, for capital gains realised on or after June 25, 2024.”

The $250,000 threshold would effectively apply to capital gains realised by an individual, either directly or indirectly via a partnership or trust, net of any:

• Current year capital losses
• Capital losses of other years applied to reduce current-year capital gains
• Capital gains in respect of which the Lifetime Capital Gains Exemption (LCGE), the proposed Employee Ownership Trust Exemption, or the proposed Canadian Entrepreneurs’ Incentive is claimed.

Keep emotion out of the equation

Nothing is worse in wealth management than undue haste, especially when it comes to the potential transfer or sale of a major capital asset such as a second home. The expression scrambling to close deals used in the opening to this blog, represents an important red flag.

Family cottage properties have, in many instances, been part of an individual family’s overall assets for decades. As a result, although they might have considerable real estate value, they have a minimal cost basis. They have been owned outright for years – so their capital gains exposure is consequently immense.

The key is to keep emotion out of the equation and think long-term. Try not to focus on the immediate financial and tax implications of the issue – unless for personal and financial reasons you absolutely must – and consider the matter as an issue of estate and trust planning.

The logic of trusts – especially now

A trust is a useful estate planning tool that you may create at any time to serve a wide variety of purposes. Many people think of a trust as an estate planning tool reserved for only the very wealthy. Not so. Some common goals of a trust are to provide protection, asset management and security for your loved ones. Scotiatrust are experts in this field and, on behalf of the clients we serve, we work with them frequently to address these kinds of challenges and more.

A trust as an estate planning tool

Consider the testamentary trust, which is an estate planning tool. The trust can include any assets – typically investments, cash, life insurance proceeds, or real estate. You appoint a trustee – which can be one or more individuals, a trust company, or both – to manage the funds. The beneficiaries enjoy the benefits of the property according to the terms of the trust Most testamentary trusts are spousal trusts or family trusts, though there are other specialised types.

For example, assets transferred to a qualifying spousal trust are entitled to the same rollover treatment available when transferred directly to the spouse. Assets are received by the trust at cost, instead of at fair market value – maximising income on capital. No tax is paid on capital gains until your spouse’s death, or when assets are sold.

A trust is a flexible instrument with many applications. For instance, if you have a vacation property that the family is not ready to manage, a cottage trust has the trustee take care of maintenance and finances, so your children can enjoy the property, then plan for ownership later – under carefully considered circumstances and, preferably, with the help of an expert.

Clarity about capital gains tax

For those of you unclear about what capital gains means, please allow me to explain. The capital gains tax is the tax individuals pay when selling an asset or capital property. Capital gains are the profits from that sale.

Common types of capital properties include cottages, securities (such as stocks, bonds and units of a mutual fund trust), land, buildings and equipment you use in a business or a rental operation. In other words, we’re not just talking about real estate transactions here.

That observation made, let’s just focus on the real estate aspect of the new legislation, which for many people is the crux of the matter. As a result of the legislation, The Globe and Mail went on to state:

“The clock is ticking for those who wish to sell or transfer their vacation homes at the lower capital-gains tax rate. Just over a week after the budget was announced, realtors say they are seeing a flood of clients looking to speed up the selling process.”

Conclusion

For anyone in this situation, the best strategy is to obtain advice from your wealth advisor, a tax expert and a realtor you trust. Don’t panic.

The options available to you – which can include but are not limited to a life insurance strategy – may be wider ranging than you think.

Like most issues in wealth management, there is no such thing as a one-size-fits all solution. You must take the time to talk it through.

Never forget that the family cottage is, for most of those who own one, the repository of special moments and great memories.

You can’t put a short-term price tag on an issue with such long-term personal and family consequences – unless you must.

Satvir S. Gill, Senior Wealth Advisor & Portfolio Manager, The Gill Group, 604-535-4722