Tax Considerations When Buying or Selling a Home

Buying or selling a home is often an exciting, yet stressful time for most. This article highlights several important tax considerations to be mindful of when buying or selling a home.

The Principal Residence Deduction

The principal residence deduction allows individuals and families to avoid paying taxes on the sale of their primary place of residence. Each year, an individual or family can designate one property that they own as their principal residence as long as the property is primarily used to live in by the individual/family.

SALE OF A PRINCIPAL RESIDENCE

CRA now requires individuals to report the sale of their principal residence on their personal income tax return in the year the property was sold. In many cases, the principal residence deduction eliminates any taxes that would otherwise result from the sale.  However, disclosure of the sale is still required.

To report, the taxpayer must disclose the address of the property, the year it was purchased, as well as the proceeds from the sale. Failure to report the sale of a principal residence can result in penalties and/or denial of the principal residence exemption.

Renting & Flipping Property

If a property is purchased with the primary purpose of renting or selling it, the property is not eligible for the principal residence deduction and the subsequent sale will cause a taxable capital gain or loss.

It is the original intention when the property was first acquired which is the determining factor.

Homebuyers’ Amount

The CRA provides a $5,000 tax credit to first-time homebuyers (those who did not live in another home owned either by themselves, their spouse, or common-law partner in any of the four previous years). To qualify, the property must be purchased with the intention of the individual/family occupying it as a principal residence within one year of purchase.

Homebuyers’ Plan

First-time homebuyers may also be able to withdraw up to $35,000 from their RRSPs to help purchase or build a home as long as the withdrawn amount is repaid within 15 years.

GST/HST Rebate for Newly Built Homes

If you have bought a newly built home, or have substantially renovated a house to use as your principal residence, you may qualify to receive a rebate for some of the GST/HST that you paid on the purchase through the CRA’s GST/HST new housing rebate.

By making yourself aware of potential tax planning opportunities before you buy or sell a property, you can avoid an unexpected bill from the taxman. After all, nobody likes surprises at tax time.  

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Common Financial Guidelines When Planning For Retirement

Preparing for retirement can be a very stressful experience, with so many factors that you need to consider.

  • How much money will I need to maintain my standard of living?
  • How much will I want to travel?
  • How long will I live?
  • What if I outlive my money?

Financial “Rules of Thumb”

There’s so much uncertainty, that financial rules of thumb for planning your retirement have become very popular – following them relieves at least some of that uncertainty.

It is important to understand the assumptions and the limitations of these guidelines so that you understand whether they are relevant for your particular situation.

YOU NEED 70% OF YOUR PRE-RETIREMENT INCOME IN RETIREMENT

This popular guideline incorporates the fact that you will not have certain expenses in retirement that you had while employed, like commuting costs and buying clothes for work.

You also won’t be saving for retirement anymore. However, there are some personal factors that can make this more of a myth than a guideline, including:

  • whether you own your home and your mortgage is paid off
  • whether your children are financially independent or you are still helping fund their university education
  • your own personal goals for retirement – your personal income replacement factor could be significantly lower, or higher, than 70%

A better way to estimate how much retirement income you will need is to track your current expenses and then adjust for the changes in your lifestyle once you retire, such as an increased budget for vacations and hobbies.

There are tools and apps that you can use to help you categorize and summarize your current spending.

However, check with your bank first, as using third-party tools that automatically download transactions from your bank accounts may violate your online banking agreement and expose you to liability if there are unauthorized transactions in your accounts. Many banks provide their own tools to help you manage your finances, or you can download the transactions and use spreadsheet software to create your own summary.

Once you have your recurring annual budget amount, adjusted for lifestyle changes, you should also budget for expenditures that do not occur annually, such as purchasing a new car or major house renovations.

If, for example, you plan on purchasing a new car every eight years, you should factor in an annual “car replacement fund” over that period to give you a more comprehensive budget amount.

Similarly, you should budget a certain annual amount as a fund for major home repairs – you might not need that money every year, but planning for bathroom and kitchen renovations, new furnaces and roofs should still be built into your retirement budget so that they don’t end up being a nasty surprise when they happen!

Budgeting a percentage of the purchase price of your home, or a specific dollar amount per square foot, are common ways to do this. As with all rules of thumb, these should be adjusted for the age of your home and how often you want to renovate it.

THE ‘4% RULE’

One of the most commonly-cited rules for estimating how much income you can withdraw from your investment portfolio without risking running out of money is “the 4% rule.” This rule comes from a study conducted by William Bengen and first published in The Journal of Financial Planning in 1994.

Bengen explored the concept of “portfolio longevity” – how long your investment portfolio would last if you withdrew a specific percentage of it in the first year of retirement – and then adjusted that amount for inflation in each successive year. He tested this against the stock market returns for a person retiring in each year from 1926 to 1976, and for initial withdrawal rates from 1% to 8%. With an initial withdrawal rate of 4% the portfolio lasted more than 33 years – even for those worst-case scenarios of retirees who lived through the Great Depression or the 1973–74 recession.

The rule provides a simple answer to how much you need to save for retirement or how much retirement income you can take from an investment portfolio, but there are some important assumptions behind this rule. His sample portfolio in the data above was 50% invested in U.S. common stocks and the remaining 50% invested in intermediate-term Treasury Bills, and it was rebalanced annually. That may be more risk than some retirees are willing to assume.

Bengen did explore this issue in his study, comparing the returns from various portfolio mixes of stocks and fixed income assets. While the 50/50 split seemed to be optimal in terms of maximizing the longevity of the portfolio, increasing the equity portion of the portfolio to 75% increased the value of the estate passed on to the heirs while having minimal impact on the portfolio longevity.

Bengen updated the study in 2006 and concluded that 4.5% was the safe initial withdrawal rate. Whether it is 4% or 4.5%, this can give you a good guideline for how much you will need to have saved by retirement to feel confident that you will not run out of money.

Once you have calculated your budget based on the retirement lifestyle that you want and subtracted what you expect to receive from the Canada Pension Plan, Old Age Security and any defined benefit pension plan, you can divide that net amount by 4% and have a reasonable target for your portfolio at retirement.

100 MINUS YOUR AGE RULE

You often hear that our tolerance for risk in our investment portfolios should decrease as we get older, theoretically, since you will have less time for your portfolio to recover from a financial catastrophe, which is where the “100 minus your age” rule comes in to play – the proportion of your investments invested in equities should be 100 minus your age, with the remainder invested In safe, fixed income assets, such as bonds. So a 40-year-old should have 60% of their portfolio invested in equities, while a 70-year-old should have a portfolio with only 30% equities.

However, with the increase in life expectancy since this rule was introduced, and with the historically low returns on fixed-income investments, retirees will risk running out of money by following this rule.

Some advisors have adjusted the rule to “110 minus your age,” or even “120 minus your age,” to address the increase in life expectancy, while another study evaluated the minimum and maximum returns for various portfolio mixes against the “100 minus your age” portfolio over a 50-year period.

This research found that the “100 minus your age” portfolio consistently underperformed against both the minimum and maximum returns for two constant mix portfolios: 60% equity / 40% bonds and 70% equity / 30% bonds. This is consistent with Bengen’s conclusions. While every individual’s tolerance for risk is very personal, the link between that risk and the expected return on the portfolio is very clear.

In summary, these common guidelines can be a good starting point for thinking about your retirement, and how prepared you are for it, but each situation is unique and therefore understanding the assumptions and limitations of the guidelines is important.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Will I, Or Won’t I?

You’ve met with your lawyer and drafted your last will and testament. Congratulations – you are doing better than half of your fellow Canadians! But drafting your will should never be a “one and done” exercise. It’s generally best practice to review your will every three to five years, to make sure that it still does what you want it to do. Certain life events should also trigger a review of your will. What are some of those?

Changes In Your Relationships

Significant changes in your relationships or family situation should trigger a review. Examples of these changes include:

  • One of your beneficiaries has passed away.
  • You have had a falling out with a beneficiary, executor or guardian named in the will.
  • Maybe you designated a portion of your estate to a favourite cause, but now you’ve identified a different charity that will be a better fit for your legacy.

MARRIAGE

In most provinces, your current will is automatically revoked when you get married, but there are some exceptions to this general rule.

For example, if the will contains an “in contemplation of marriage” clause that identifies your future spouse by name, that will would not automatically be revoked. If your will is revoked and you do not make a new one, when you die you will be considered to have died “intestate,” and your estate will be distributed according to the succession laws in the province where you live.

It is worth noting that these laws vary widely between the provinces, including whether or not they cover common-law spouses. The provincial family law legislation may also interact with the succession laws to provide additional options for the surviving spouse – so reviewing your will when you get married is an absolute must!

DIVORCE

The impact of a divorce on your will also depends on your province of residence. In some jurisdictions, the entire will is revoked, while in others only those provisions relating to your former spouse are revoked.

If you are legally married, separation from your spouse will generally not have an impact on your will. The impact of a separation for common-law spouses varies from province to province, so you should consider making a new will whenever a legal marriage or a common-law relationship ends.

NEW ADDITIONS TO YOUR FAMILY

The birth or adoption of a child is another event that should trigger an update of your will. In addition to selecting a guardian for your minor children, you may want to establish a trust to hold the property for those children until they reach a specific age.

You should review these sections periodically to ensure, for example, that the person whom you have selected as the guardian still has the time, interest and ability to devote to looking after your children.

And, if your will was to establish a trust for your children until age 25, as you see your children grow is that still the right age? Or are they mature enough that they could handle their inheritance at, say, 18 – or maybe not until they are 30 years old?

You should also consider whether your will should be updated when the youngest of the children reach maturity, finish post-secondary education, or get married or divorced as well.

Changes In Your Assets

In addition to major changes in your relationships, significant changes in your assets should also trigger a review of your will.

The need to review may arise through changes in the relative value of your assets. For example, if you plan to leave your home to one child, the family business to a second child and your investment portfolio to the third child, and the relative value of those assets has changed, you may want to change the terms of the will to be fair to all of your beneficiaries.

Another factor that may affect the value of the assets could be changes to Canadian tax legislation, or international tax legislation if you own any foreign assets.

When you review your will after a significant life event or change in your assets, it is also important to review the named beneficiaries for your Registered Pension Plan, Registered Retirement Savings Plans, Tax-Free Savings Account and life insurance policies, to make sure that these reflect your current situation and wishes.

It’s also a good time to review your powers of attorney, which name someone to act on your behalf if you are unable to. There are two kinds of power of attorney: one for property, naming the person who can make decisions about your financial affairs; and one for personal care, naming the person who can make decisions about your healthcare, housing and other aspects of your personal life.

Finally, as noted above, the laws governing family law, wills and estates are provincial, rather than federal, so if you move between provinces it’s time to review your will and other related documents.

Your CPA Can Help

In addition to consulting with your lawyer, reviewing your estate plan with your CPA will help give you peace of mind that your estate will be distributed in the most efficient and effective way possible, in accordance with your wishes.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

TFSA and Death: Have You Planned For What Will Happen With Yours When You Die?

If you own a TFSA, you undoubtedly started it because it allows you to invest and earn dividend or interest income and make a capital gain without paying tax.

Unfortunately, similar to any investment vehicle, complications may arise after your death unless you address the tax consequences in advance. Consider the following circumstances that can affect what happens with your TFSA after you die.

SUCCESSOR HOLDER

If you have named a survivor — your spouse or common-law partner — as a successor holder, then that individual acquires all the rights of the original holder and thus becomes the new account holder.

With this scenario, the TFSA does not terminate and thus there are no tax consequences to the new account holder. An additional benefit may accrue if the original holder has overcontributed before they passed and the new account holder has contribution room in their TFSA.

In this situation, the overcontribution by the deceased can be absorbed by the new account holder into their TFSA, thereby eliminating the chance of future overcontribution penalties (currently at 1% per month).

ROLLOVER PERIOD

Assume for a moment that the deceased did not designate the spouse or the common-law partner as a successor holder. What then?

If the spouse or common-law partner named in a will are accorded an inheritance that includes the TFSA, they can transfer their spouse’s TFSA to their own TFSA within a prescribed time period, called the “rollover period.”

The rollover timeframe is explained as starting at the time of death until December 31 of the following year. During this rollover period the investment income is sheltered from income tax.

If the beneficiary decides to transfer funds to their own TFSA during the rollover period, these transfers are considered to be “exempt contributions” and as such do not require that the beneficiary have room in their own TFSA. However, the amount of the transfer is limited to the fair market value (FMV) of the TFSA as at the original holder’s time of death.

Thus, if at the time of death, the FMV was $50,000 but at the time of transfer the value of the TFSA was $55,000, then the $50,000 could be transferred without any impact.

However, the $5,000 increase would either have to be absorbed by the beneficiary if they have room within their TFSA or be included within the beneficiary’s income within the year of the transfer.

NAMED BENEFICIARY

When you die without a spouse or common-law partner, the TFSA is collapsed at the date of your death. The amount of the TFSA can be transferred to the named beneficiary tax-free, but only up to the amount of the FMV of the TFSA at the date of death. Naturally, the beneficiary would need to have TFSA room to absorb the FMV transfer.

For instance, if the beneficiary had $30,000 of accumulated TFSA room and the FMV of the transfer was $55,000, $30,000 would be transferred tax-free while the excess $25,000 would be considered withdrawn and part of the beneficiaries inheritance with no additional Canadian tax consequences.

This calculation does not account for any increase in FMV that may have occurred since the date of death.

FORM RC 240

It is worth noting that when a contribution is made to the successor holder’s TFSA, the successor holder has 30 days from the date of contribution to fill in Form RC 240, Designation of an Exempt Contribution Tax-free Savings Account (TFSA).

As you can see, there are potential tax complications with a TFSA when a taxpayer passes. Remember also that the provinces and territories are responsible for the rules governing the transfer of assets of a deceased.

Fortunately, the CRA and their provincial/territorial counterparts have agreed that having the named beneficiary on the TFSA application will allow transfers without inter-jurisdictional complications.

Quebec may be an exception, wherein the TFSA transfer goes to the estate and the will of the deceased comes into play.

Since TFSAs are registered with the CRA, an astute taxpayer would want to determine the tax consequences, either when their TFSA has a named survivor or when the will takes precedent.

It’s probably worthwhile to confirm that your CPA is aware that you have a TFSA. Then, should you die unexpectedly, your tax advisor can assist your successor holders or beneficiaries.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.
Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.