The Globe and Mail recently published an article which discusses whether or not parents should add their children to the title of their properties as a way of avoiding probate (more formally known as the Estate Administration Tax), a fee paid upon the registration of a will.  There’s just one problem with the article: it has glaring omissions regarding tax law, because it was written by asking an estate administration lawyer, not a tax lawyer.  The article is talking about trying to avoid the Estate Administration Tax at 1.5% in Ontario, but suggests a strategy which very easily could land you with liability for the capital gains tax, which can be over 25%.  Beyond that, it doesn’t bother to explain that its suggested method is actually a species of fraudulent misrepresentation, because they also did not consult a lawyer with any expertise in property law.  In this article, I will explain why.

Joint Tenancy: The Four Unities

The Globe’s article only looked at the issue of title to the property from the point of view of a family feud.  While this is a perfectly valid concern, in that a child being on title is presumptively intended to inherit the full title to the property unless otherwise stated, this does not come close to explaining all the concerns here.

First, we have to consider the nature of title, and in this case, joint tenancy.  A joint tenancy is where all those on title have a joint ownership of the whole property, as opposed to owning shares of it expressed in percentage terms.  Joint tenancy comes with what is called a right of survivorship, meaning if one person dies the others are now the owners of the whole property; there is no share which passes through the estates system, which is why the Globe’s article addresses this as a way to avoid probate fees.  There is just one problem with this: you cannot legally simply add a child to the title to the property.  In order for a joint tenancy to be legally constituted, the ‘four unities’ must be present.  These are unity of time, title, instrument and possession, and date back to the old English common law.  The first three unities can be created by putting someone on title, because everyone can go on title at the same time, using the same instrument.  The last element though, possession, is a factual determination based on the use of the property.  All those in a joint tenancy must possess the whole of the property in the same way.  If the parents live in the house and a child going on title does not, that is not a legal joint tenancy, because the child did not possess the property in the same way, he did not have actual use of it.  Similarly, if a property were divided into multiple units, two people living in separate units could not own the whole building as joint tenants, because they each have exclusive use of their respective units.  All joint tenants must possess a property in the same way, whatever that use may be.  Joint tenants may own a property used as a cottage or vacation property, as an income property, or a principal residence, but whatever the use, it must be the same for both.

This is a glaring omission in the Globe’s article, because the child added onto title to the property could have the joint tenancy challenged by the other children, on the basis that it was never properly constituted.

Capital Gains Tax

While the Globe’s article does mention capital gains, it only does so in the context of a property like a cottage which will have capital gains on it anyway, and a transfer to a child creating the liability for that tax early.  This is a perfectly valid concern, but again, not the biggest one.  Let’s consider their scenario before we get onto another they missed completely.

Capital gains taxes are payable when someone ‘disposes’ of a capital asset, as defined in the Income Tax Act.  You are deemed to have disposed of assets when you die, so any capital gains taxes are payable by your estate.  If you give a capital asset as a gift, that is also a disposition, so capital gains taxes are payable by you in the year you make that disposition.  Putting a child onto the title for a cottage or income property would be a deemed disposition unless specific steps were taken to make sure it was not considered as such.  What would be tricky is determining exactly to what extent you have disposed of the asset.  As stated earlier, adding someone on as a joint tenant does not involve a percentage ownership on the title, so you cannot claim the child added to title only owns 1% of the property and only pay that tax.  CRA would assume an equal ownership (though this is actually just as wrong) and you would need to provide proof that some other percentage ownership was intended, and if you could not provide documentary evidence, CRA would rule against you.

You could also become liable for land transfer tax when transferring to a child.  LTT (and MLTT in Toronto) is payable when the ownership of a property changes.  By adding a child, you have changed the ownership.  There are exemptions, such as when the change occurs because of death, but by transferring it during your lifetime, you cannot make use of that advantage.  Doing this is a classic example of people getting so concerned about probate fees, which they don’t understand, that they run right into bigger problems they understand even less.

Let us now consider the even bigger problem the Globe’s article misses entirely: the exposure of the principal residence to possible capital gains taxes.  Right now you’re probably thinking that principal residences are exempt from capital gains tax.  You’re right, but as with all things in tax law, that exemption is subject to very specific technical rules.  One of those rules is that to apply the property must be owned by the people who are on title.  If you add a child to the title, that will not be true anymore.  This will expose the property to capital gains taxes to the extent of the child’s ownership share from the date on which the child was added to title.

Solution: Complexity and Administration

There is a solution to all of this, but it is unfortunately complex and administratively burdensome, and many will decide it is probably not worth the trouble.  The answer is a formal trust arrangement, where the terms of the trust mirror the intention in the parents’ will.  The reason this is necessary is because in order to avoid liability for taxes formalities about the beneficial ownership of the property must be observed, and provably so.  First, as to the unities and joint tenancy, a child is capable of being on title as a joint tenant in the role of trustee of a trust for the benefit of the parents, with the subsequent beneficiaries being the beneficiaries of the parents’ wills, because then there is unity of possession.  The parents, as beneficiaries of the trust, possess the property, and the trustee only need possess it in the context of holding it for the beneficiaries.  Second, as to the probate fees, if a child is on title as a trustee he will become the sole owner when the parents die, but that ownership will be in the role of trustee for the beneficiaries of the estate.  The probate fees are avoided, without breaching other rules.  Third, the Land Transfer Tax.  The transfer now occurs because of the death of the parents, and transfers which occur by reason of death are exempted from LTT (and MLTT), so that tax is effectively avoided as well.  Finally, the capital gains taxes.  This is the hardest part.  In order to maintain the exemption from capital gains taxes on a principal residence the trust must file returns of income in which it designates the property as the principal residence of the beneficiaries.  This means that for all this to work, the trustee must register the trust with CRA, and file annual returns, even though the trust will not earn any income, in which the trustee states that the property (or the portion of it owned by the trust) is occupied by the beneficiaries (the parents) as their principal residence.

Needless to say, you should consult with lawyers with expertise in estate planning, property law and tax law before attempting to set up a structure of trust ownership and wills to safely navigate all these problems.  Few lawyers have expertise in all these areas, so consulting with a firm which has lawyers who do each may be necessary.