By DIANNE MALEY
Special to The Globe and Mail
Saturday, July 21, 2018
At the age of 67, Ed and Alexa are reaping the rewards of years of saving and investing: Rising income and the prospect of big capital gains down the road. They are retired with three grown children.
They have amassed a nicesized real estate portfolio comprising five rental apartments in Vancouver in addition to their own principal residence. They also have substantial financial investments. As the mortgages on the rental properties are paid down over time, Alexa and Ed's income has been rising - and so has their tax bill.
"We'll soon have to convert our RRSPs to registered retirement income funds (RRIFs), resulting in even more taxable income," Alexa writes in an e-mail.
They're worried about having their Old Age Security (OAS) benefits clawed back if their income is too high.
"We have three children and we intend to pass down our assets to all three equally," Alexa adds.
"We'd like to avoid as much tax as possible and organize our affairs so that our beneficiaries inherit the maximum amount.
What can we do about our rental property capital gains?" We asked Brinsley Saleken, a fee-only financial planner and portfolio manager at Macdonald Shymko & Co. Ltd. in Vancouver, to look at Alexa and Ed's situation.
WHAT THE EXPERT SAYS
Alexa and Ed are financially independent, even without their real estate, Mr. Saleken says.
They are spending about $60,000 a year after tax.
"There are still a number of potential issues that need to be dealt with to prevent any tax complications further down the road," the planner says.
They are taking the right approach with their investments, selling some stocks, paying the capital-gains tax and transferring the proceeds to their tax-free savings accounts, where future gains will be sheltered, he adds.
They also make charitable contributions.
"One avenue to explore would be making contributions in-kind to their chosen charity, using those stocks with the largest capital gains," Mr. Saleken says. They would get a tax credit for the market value of the stocks and would not have to pay capitalgains tax on the disposal.
Both Alexa and Ed are in the 22.7-per-cent marginal tax-rate bracket now, so they have a "reasonable buffer" before they have to start worrying about the OAS clawback, which begins when an individual's taxable income surpasses $73,750 a year.
If anything, they may want to increase their income periodically through RRIF withdrawals or realized capital gains, even if that puts them in a higher tax bracket (28.2 per cent), as long as they stay below the OAS clawback threshold.
This would leave a lower amount to be taxed on the final deceased tax return, which likely would be at the highest tax bracket of 49.8 per cent (federal and B.C.), the planner says.
This leads to the question of the embedded capital gains on the rental properties.
"There isn't much that can be done to shelter real estate capital gains from taxation," Mr. Saleken says. "It's important to remember that the tax is the result of a successful investment."
The couple might want to consider selling some or all of their rental properties rather than leaving them to form part of their estate, the planner says.
They could sell one a year for the next five years, for example.
Although this would result in an OAS clawback, "our analysis shows that this would be more tax-efficient in the long run."
If they are not sold, the rental units would be deemed to have been sold in the final deceased tax return.
Alexa and Ed could use the sale proceeds to develop a more tax-efficient investment portfolio.
As well, having so much of their net worth in real estate exposes them to more risk than necessary, the planner says. The capitalization rate (rate of return) on their rental properties, based on assessed value, ranges from 1.79 per cent to 2.12 per cent - less than the yield on a Government of Canada bond, Mr. Saleken notes.
If they sold a property or two, Alexa and Ed could increase their spending and perhaps travel more or take up a hobby. They would also lighten the burden of being landlords. "They deserve to reward themselves."
Another benefit of selling while they are still around would be to provide early inheritances for their children, the planner says. This could be done in a staged approach, "which has far more privacy, flexibility and potential tax-efficiency than passing it on via the estate," the planner says.
For example, one of their rental properties has a capital gain of $374,000 (only half of which is taxable).
"Based on current income, if this was sold and realized, the tax shared between Alexa and Ed would be roughly $72,000, whereas the tax, if part of a deemed disposition at their passing, would be roughly $93,000, given it is likely that all of the gain would be taxed at 49.8 per cent."
If they decide not to sell their rental properties, the couple must figure out how their estate will pay the capital gains tax that will come due on the final return.
"One option would be to take out a life insurance policy to cover the expected tax due on the survivor's final return," Mr. Saleken says.
The downside is they'd have to pay the insurance premiums in the meantime.
The people: Ed and Alexa, both 67, and their children, who range in age from 34 to 40.
The problem: How to arrange their investments in a taxefficient manner.
The plan: Consider selling one or more properties and giving some money to their children now. Alternatively, explore insurance to pay the capital gains tax on their estate.
The payoff: Avoiding potential tax complications for their heirs.
Monthly net income: $6,510 (net rental, CPP and OAS, investment income).
Assets: Principal residence $1,300,000; rental properties $2.7-million; joint non-registered portfolio $115,320; her nonregistered portfolio $77,875; his savings account $16,840; her registered retirement savings plan $399,813; his RRSP $300,895; her TFSA $68,214; his TFSA $66,397. Total: $5.04million Monthly outlays: Condo fee $515; property tax $175; home insurance $40; hydro $50; maintenance $40; house cleaning $125; transportation $445; groceries $375; clothing $100; line of credit $375; charity $460; vacation, travel $835; dining, drinks, entertainment $405; club memberships $320; subscriptions $15; health care $290; phones, TV, internet $160; RRSPs $915. Total: $5,640 Liabilities: Rental property mortgages $634,700; line of credit $114,000. Total: $748,700