Real Estate Opportunities in a Downturn (Part 1): Estate Planning Strategies to Minimize Death Taxes
Part of our Real Estate Opportunities in a Downturn series exploring tax-efficient strategies for property owners.
Key Takeaways
- Lower property values can reduce capital gains tax on intergenerational transfers.
- Estate freezes allow future growth to transfer to the next generation without immediate tax.
- Re-freeze transactions may further reduce future death taxes if property values decline.
- Strategic estate planning during a downturn may significantly reduce final tax liabilities.
Why Can a Real Estate Downturn Create Estate Planning Opportunities?
Declining property values and slow housing sales are never a welcome sign in the economy. However, when they do occur, depressed real estate values can present some unique opportunities from a tax planning perspective.
This blog post discusses a few of these potential opportunities.
Opportunity 1 – Intergenerational Property Transfers at Depressed Fair Market Values
In Canada, there is a tax cost involved when the ownership of property is transferred from one generation to the next.
Specifically, when ownership is transferred, the transferor is deemed to dispose of the property at its fair market value, often resulting in a significant capital gain for tax purposes. This type of deemed disposition often occurs at the time of one’s passing and results in “death taxes” on the final tax return of the deceased.
Opportunity: When property values are lower, it may be a good time for property to be gifted or sold to the next generation. The transfer will occur at the property’s fair market value, so if the value of the property is lower at the time of transfer, the taxes resulting from the transfer can be minimized or even eliminated in a loss situation.
However, appropriate caution should be taken with this strategy. Gifts and transfers will often result in immediate taxes payable, as well as property transfer taxes, and cannot be easily reversed without further tax and legal implications. The needs of the transferor must also be taken into consideration since they will no longer own the property.
Opportunity 2 – Implementing an Estate Freeze During Depressed Property Markets
In certain cases, it is also possible to facilitate an ownership transfer to the next generation using an “estate freeze”. Estate freezes typically involve a Canadian corporation.
Under a typical estate freeze, the transferor may retain the ability to control the transferred property, but the value of the transferor’s interest in the property will be “frozen” at the current fair market value and allow future growth to accrue to the next generation. Generally, no taxes are payable at the time of a typical estate freeze.
Estate freezes are a very powerful tool in estate planning because they:
- Do not result in immediate taxes;
- Allow the transferor to retain control of the “frozen” property; and
- Facilitate an ownership transfer to the next generation by limiting the future death taxes at the “freeze” amount.
Opportunity: The “freeze” amount in an estate freeze will be based on the fair market value of the property at the time of the freeze. Lower property values can mean an optimal time to conduct an estate freeze because it presents an opportunity to conduct the estate freeze at a lower “freeze” amount. By freezing at a lower amount, the transferor’s final death taxes at the time of death will be reduced.
Opportunity 3 – Revisiting a Prior Estate Freeze After a Decline in Value
After an estate freeze has been completed, it is also possible to re-do the estate freeze with a new value.
This is commonly referred to as a “thaw” or “re-freeze” transaction.
In an estate re-freeze, the transferor’s interest in the property will become “frozen” at the new fair market value at the time of the re-freeze. If a re-freeze occurs at a lower value than the original freeze value, future estate taxes on death would be reduced because of the lower “re-freeze” amount. Similar to estate freezes, re-freeze transactions typically do not result in any immediate taxes payable.
Opportunity: If an estate freeze has been done in the past but the “frozen” property has since declined in value, there can be an opportunity to do a “re-freeze” transaction. This would have the benefit of further reducing future estate taxes beyond the original estate freeze.
Is it the right time for estate planning?
A downturn in the real estate market for families with significant real property holdings may present significant financial challenges but may also provide significant planning opportunities. The above are a few potential examples of tax planning opportunities which present themselves when property values are lower.
Estate planning decisions should only be made after fully taking into consideration your corporate structure, your financial situation, your cash needs, and your future goals and objectives. It is crucial to fully discuss these factors with your professional advisor before moving forward with the opportunities suggested above. This blog post should not be relied upon and is not advice.
Estate planning transactions can be very complex and the above is a very high-level summary. We strongly recommend consulting with a Smythe advisor if you are considering an ownership transfer to the next generation.
