Title: Barney s Investment Property & Estate Planning Options. Case Stem

Transcription

1 Title: Barney s Investment Property & Estate Planning Options Case Stem Barney, age 62, is employed as an area manager for a large petroleum company. His current year employment earnings are $110,000. He is a widower and has two adult children, Lucy, age 36, and Mindy, age 33. Lucy is married and has two young daughters. Mindy, also married, has two young sons. Lucy and Mindy each own their own home and both have mortgages over $250,000. Last year, Lucy and Mindy started an interior design business. Their business, structured as a partnership, is in its second year. In the first year the business suffered a loss; this year Lucy and Mindy are expecting to report a profit. Ten years ago Barney purchased an investment property for $50,000. Today it is worth $200,000 and generates $11,000 net income per year. Since the investment property is in a good area, Barney expects the value of the property to continue growing. Barney has not claimed CCA on this property to date. When he dies, Barney would like his daughters to own the investment property and is exploring three estate planning options to accomplish this goal. He is considering: 1. transferring the property into joint tenancy with his daughters 2. transferring the property into a trust and naming his daughters residual beneficiaries of the trust 3. including a clause in his will that transfers the investment property into a trust for his daughters Barney s marginal tax rate is 42%. His average tax rate is 31%. 1

2 Question 1 Response Instructions Calculate the immediate taxes payable if Barney transfers the property into joint tenancy with his two daughters today (option 1). Show all calculations. Assume Barney, Lucy and Mindy would have equal ownership, 1/3 of the property each. Other than immediate taxes payable, explain two two disadvantages that Barney should consider related to transferring the property to joint tenancy. (5.5 marks) Response Template Taxes Payable Calculations (1.5 marks) 1 Explain Advantage of transferring the property to joint tenancy (1 mark each) Explain Disadvantage of transferring the property to joint tenancy (1 mark each) 2 2

3 Sample Response Taxes Payable $21,000 Calculations (1.5 marks) Capital Gain = 2/3 x (200,000 50,000) = 100,000 Taxable Capital Gain = 50% x 100,000 = 50,000 Taxes payable = 50,000 x.42 = 21,000 Advantage of transferring the property to joint tenancy (1 mark each) 1 With the property in joint tenancy when Barney dies it will not go through his estate. He will not have to pay probate on the investment property and it will not be on his list of assets at death. His estate and his heirs will have privacy related to this asset. 2 With joint tenancy at Barney s death the asset will transfer automatically to the surviving joint tenants. There will not be delays nor disputes that can happen with the assets in the Barney s will. 3 Barney can split income related to the investment property with his daughters. Since they are adults, there will be no income attribution back to Barney; the income will be divided by three. Disadvantage of transferring the property to joint tenancy (1 mark each) Barney will lose control of the property. His daughter can make changes to the property or sell their portion without Barney s consent. Both Barney s daughters are married. If either of their marriages breakdown the investment property may be included in family assets. Barney s daughters run their own business. The business is in the start up phase and could run into financial difficulty. Since their business is not incorporated creditors of the business can access the daughter s personal assets including the investment property. They both have significant mortgages, creditors are likely to access assets beyond their homes. 4 At his death Barney s portion of the investment property will automatically transfer to his daughters. This may not be Barney s intended flow of the asset. One daughter may be better at managing investment properties. 3

4 Scoring Table Task # Indicator Mark Competency Calculates taxes payable from deemed disposition. 1 Calculates capital gain of $100, Identifies the client s current tax liabilities 2 Calculates taxable capital gain of $50, Identifies the client s current tax liabilities 3 Calculates taxes payable as $21, Identifies the client s current tax liabilities Explains 2 2 disadvantages of transferring to joint tenancy. 4 Identifies and explains first advantage 5 Identifies and explains second advantage 6 Identifies and explains first disadvantage 7 Identifies and explains second disadvantage Total 5.5 Complexity: Moderate Technical Knowledge 106 capital gains, 506 personal property ownership & transfer rules, 501 family law, 506 personal property ownership & transfer rules Rationale Clients often want to set up their assets to reduce probate. One of the ways to accomplish this is to register assets in joint tenancy with rights of surviviorship. Although this will reduce probate, clients are often unaware that transfer of a property is a deemed disposition and will often result in capital gains taxes that must be paid. Joint ownership of assets has pros and cons that should be understood fully by the CFP professional. The cons of joint ownership should be explained to the client so they understand the downside of this type of ownership. 4

5 References Contempory Practices in Financial Planning CCH Advocis Education Program Course 2 page 6-27 Financial Planning Fundamentals CCH/Advocis Education Program Course 1 page 3-14 and pages

6 Question 2 Response Instructions Explain two two disadvantages of the second option Barney is considering; transferring the investment property into a trust today. Barney would be the only beneficiary of the trust during his lifetime; when he dies the trust assets will transfer to his daughters in equal proportion. (4 marks) Response Template 1 Explain Advantage of transferring the property to a trust (1 mark each) Explain Disadvantage of transferring the property to a trust (1 mark each) 2 Sample Response Advantages of transferring the property to a trust 1 Barney will retain control of the property since he is the settlor of the trust. 2 The trust assets will not go through Barney s estate at his death. His estate will not have to pay probate on the investment property and it will not be on his list of assets at death, so his estate and heirs will have privacy related to this asset. Disadvantages of transferring the property to a trust Trusts are expensive. Barney would need to pay to set up the trust and for annual reporting requirements. Since Barney is 62 years old he will set up a family trust. There will be a deemed disposition of the investment property and Barney will need to pay capital gains taxes now. He will pay 50% (FMV ACB) x 42% = $31,500 in tax now. 3 Barney could live many more years. Trusts are subject to the 21 year rule or a deemed disposition every 21 years. 6

7 Scoring Table Task # Indicator Mark Competency 1 Identifies and explains first advantage Explains 2 2 disadvantages of transferring the property to a trust today. 2 Identifies and explains second advantage 3 Identifies and explains first disadvantage 4 Identifies and explains second disadvantage Total 4 Complexity: Moderate Technical Knowledge 508 Trusts, 112 Intervivos Transfers Rationale An Intervivos trust, or family trust, is an option to consider in Estate Planning. It allows the settlor control over the assets during his lifetime, but has significant set up costs and tax implications. References Wealth Management and Estate Planning CFP Education Program Course 4 page

8 Question 3 Response Instructions Explain two two disadvantages for Barney in using option 3; including a clause in his will that transfers the investment property into a trust for his daughters when he dies. (4 marks) Response Template 1 Explain Advantages of setting up a trust in his will (1 mark each) Explain Disadvantages of setting up a trust in his will (1 mark each) 2 Sample Response Advantages of setting up a trust in his will (2 marks) 1 Barney will retain ownership and control of the property while he is alive. 2 Based on Barney s experience with his daughters and how things go with the relationship and/or the property, Barney retains the flexibility to change his will. 3 Capital gains taxes will be deferred until Barney dies. Taxes will be less of a concern for Barney. 4 Less tax will be paid on income in the trust since the income will be taxed at progressive tax rates. Also, the trust income can be split between the trust and the daughters based on whichever way results in the lowest taxes. Note that these rules will be changing as of 2016 and graduated rates will only apply for the first 36 months. Disadvantages of setting up a trust in his will (2 marks) The investment property will go through Barney s estate at his death. His estate will have to pay probate on the investment property. The investment property will be included on his list of assets and part of the public record. Lucy and Mindy will share the trust assets. Shared ownership can lead to disputes. However, since they own a business together this may be less of a concern. Since Lucy and Mindy are young they are expected to live for many more years. Trusts are subject to the 21 year rule or a deemed disposition every 21 years. His stated objective is that his daughters own this property on his death. With the use of a testamentary trust, the trust will own the asset on his death. There will be costs to set up and maintain the trusts that could offset some of the benefits. 8

9 Scoring Table Task # Indicator Mark Competency 1 Identifies and explains first advantage Explains 2 2 disadvantages of setting up the trust in his will. 2 Identifies and explains second advantage 3 Identifies and explains first disadvantage 4 Identifies and explains second disadvantage Total 4 Complexity: Moderate Technical Knowledge 508 Trusts, 112 Intervivos Transfers Rationale Indicators 1 4: Often the most effective way to deal with the transfer of assets is to set up a trust via the will. This allows the existing owner to continue to control and obtain income from the asset. At the death the asset transfer to the beneficiary, in a trust. This trust provides the beneficiary tax benefits; access to progressive tax rates on trust income. References Wealth Management and Estate Planning CFP Education Program Course 4 pages to 34 9