Joint Ownership – An Estate Planning Trap for the Unwary

Avoiding probate fees, or the estate administration tax as it is called in Ontario, is a pre-occupation amongst many Canadians. This is particularly true in jurisdictions where the rate is considered excessive. The top rate in Ontario is currently 1.5%, but Nova Scotia has a higher rate at 1.695%, and neither province has an upper limit on the total paid.

To put this in perspective, the top estate administration tax rate in Ontario translates to $15,000 per million dollars of estate value with the other $985,000 staying in the estate to pay debts and taxes and then be divided amongst the beneficiaries. Proportionately, the tax is small which does not explain the effort expended to avoid it that can be worse than the perceived problem.

One of the most common probate planning strategies attempted is the use of joint ownership. For example, a parent will transfer an investment account, or even his/her home, into joint names with some of the children or maybe a favourite grandchild. The investment account would be stated to be “joint with rights of survivorship” and the real estate would be registered as “joint tenants”.

This sounds simple enough, but it is important to understand all of the implications of joint ownership. Here are the lesser-known facts about joint ownership:

1. You no longer completely control the asset. As a result, it can be subject to the claim of creditors of the other co-owners or even family law claims. With respect to real estate in particular, if you want to sell or re-finance, you need the consent of the other co-owners, which they do not have to provide.
2. The transfer to joint ownership can trigger immediate income tax consequences since you are disposing of a partial interest in the asset.
3. If the asset is your principal residence, the portion transferred will no longer be your principal residence and likely not eligible for the income exemption when ultimately sold.
4. It is possible to die out of order and undermine the terms of your Will. This happens because, as co-owners die, their interest in the joint asset ceases and the asset is then owned between the surviving co-owners until there is only one surviving owner. For the people who die first, their interest does not flow down to their children or grandchildren and the disposition of the asset is not governed by the terms of the Will. Therefore, any alternate gifts contained in your Will in case someone predeceases you have no impact on the joint asset. As a result, the joint asset is distributed one way and the balance of the estate in a different way. Generally, this is not what most people expect or want.

An example will help illustrate. Let’s say Fred has three children and his spouse has predeceased him. He lives in the GTA and his home value has soared. As a result, he decides to transfer his principal residence, which is now worth $2.4 million, into joint tenancy with his three children. For easy math, we will assume the purchase price was $400,000. The estate administration tax on $2.4 million is $36,000. However, it would take only an increase in the value of the property of about $200,000 for the income tax consequences to start to outstrip the estate administration tax savings.

The three quarters of the home that no longer qualifies as a principal residence would result in a taxable capital gain when sold and the marginal rates of the children would apply. If they are in the top tax bracket, a relatively small increase in house value overtakes the probate savings but the risks remain. Aside from Fred losing control of his home, suppose child #2   edeceased him leaving two children who Fred wanted to get the parent’s share and this is how his Will is drafted. Those two grandchildren will not share in the proceeds of the sale of the home since it will pass outside the estate and, therefore, the Will.

If we now assume Fred has an investment account worth $2.4 million and the same cost base of $400,000, the harsh consequences of a transfer to joint names with the children is more significant, as well as immediate. Fred would have an immediate taxable gain of $2 million and a taxable capital gain of $1 million. Assuming a combined federal/provincial marginal rate of 50%, this would result in $500,000 of income tax owing in the year of the transfer.

The Supreme Court of Canada considered a similar situation to the example of Fred transferring his investment account into joint names with his adult children. However, in that case the parent argued that he was just transferring the “right of survivorship” and the court curiously agreed. Regrettably, the court overlooked a serious logic error with this proposed strategy, as well as the fundamentals of trust law, and the decision has been greatly criticized as a result. In addition, some people have tried to extend the application of the decision to situations where it was never intended to apply further complicating matters.

The options for minimizing the estate administration tax in ways that do not create more problems than they solve are limited. One of the best options is the use of a trust. Another is the use a secondary Will for non-probatable assets such as private company shares, although this is not an option in all provinces.

For clients focussed on minimizing the estate administration tax, I would suggest that they not get distracted from the true purpose of estate planning, which is structuring your affairs in an orderly fashion that reflects the unique needs of your family and does no trigger unintended income tax consequences or undue risk to self or beneficiaries. Sometimes a pound of cure can be worse than the disease.

The foregoing should not be considered to be legal advice and should not be relied upon as such. Please consult a lawyer to get advice and an opinion on your unique circumstances.