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Estate Planning: What Happens after Happily Ever After?

I always have great conversations with my bookkeeper. Her name is Lihua.

She lives close to me and was really just looking for a part-time role working from home and we clicked immediately.

She’s been a stay at home mom for years to raise her son. She knows I am a real estate investor and she often asks me for real estate investing advice.

In fact, many investors come to me to ask me for advice.

Lihua told me that her friends bought a few student rentals near Mohawk College and rented them out as student rentals.

We have properties in the neighborhood as well.

Her neighbors can’t sleep at night. They worry about students burning down their houses.

They don’t have insurance.

WHATTTTTTT?!

Yes, they don’t have insurance, trying to save a few bucks so they can get higher cash flow. And they can’t sleep at night.

I was shocked when she told me that. If your properties cannot get enough rent to cover all the expenses, don’t invest in it!

There are other investment options available that you can generate a guaranteed amount of cash flow (10% return on investment) and there’s no headache from being a landlord.

You are the average of the five people you hang out with the most. This saying is very true.

Lihua came to me and asked me what I thought about buying pre-construction detached homes in Oakville about a year ago.

Her friends were doing it and she also put in an offer. She decided to back out because the price tag of the house was $1.3M.

Her family, for the most part, relies heavily on her husband’s income. Her husband is an engineer and makes a decent salary.

Thankfully she didn’t. Her husband hurt his back while doing yard work at home. He had always been a contractor and he had no insurance coverage.

Imagine you had to pour out the deposits when you don’t know if you can get back to work?!

I told her I wouldn’t personally invest in these new pre-construction homes because I don’t have deep pockets.

I only invest in houses that I can generate positive cash flow. I know this may not be where the big money is, but I can sleep at night knowing that I don’t have to continue to work for the properties and paying into them every month.

Rental income is bigger than expense. When the market goes up, I am happy. When the market goes down, I am not concerned.

Everyone invests differently. My best friend, who’s got much deeper pockets than me, frequently buys and sells Toronto properties.

None of them cash flow. But all of them can be sold for a lot more.

These are the things that would cause me headache and I surely won’t be able to sleep at night.

So I pick my own strategy. Still works. 🙂

Now on to this week’s topic:

Recently I attended a few workshops and professional development courses about estate planning.

Estate planning can be very sad.

You work so hard for all your life to accumulate this much, only to find out that you have to pay so much tax at death.

But without proper estate planning, you may be facing children suing each other over who gets a bigger share of your estate.

Estate planning itself is a huge topic and involves many specialized professionals. It’s tough to cover everything in one blog post. Let’s start from learning what would happen if there is no planning and no will.

Many real estate investors’ goals are to purchase 10 properties, have them fully paid off and use the rental income as their retirement fund after.

If you have ten properties purchased for $300,000 at the age of 35, by the age of 85, your portfolio can be worth as much as $13million dollars with 3% appreciation compounded annually.

Good news is that with time, we are all going to be millionaires.

Bad news is that with time, we all have to pay a lot of taxes!

In Canada, when a taxpayer passes away, all assets are deemed to dispose at fair market value at the time, unless he/she has a spouse to rollover the assets at cost base.

So with ten properties at the age of 85 worth $13million all fully paid off, what’s the tax impact on this?

Fair market value = $13million, adjusted cost base (purchase price) = $3million, capital gain = $10million

Based on today’s tax law, 50% of this capital gain is taxable, so you have $5million taxable income in your personal name. (You can easily refer to my previous blog post on how to calculate tax payable on sale of properties here.)

Currently the highest personal marginal tax rate is 54% in Ontario, so a tax bill of $5million x 54% = $2.7million.

This is equivalent to the value of two houses that you gotta sell to pay off the tax bill.

If you are a saver, you also have a large balance in Registered Retirement Saving Plans (RRSPs). This is also taken into income all in one shot at the terminal return.

If you have $500,000 in your RRSP, this $500K is taken into income at the terminal return all in one shot. With 54% highest marginal tax rate, you simply have to pay $500K x 54% = $270K to the government.

A total of whopping $2.97M gone to CRA.

And then there’s also something called Estate Administration Tax (commonly referred to as probate tax).

It’s another layer of tax imposed by the Ontario government.

Probate is 0.5% for the first $50K and 1.5% above and beyond that amount.

For a rental portfolio of $13million, you will be charged an additional $194,500.

Combine total due at death = $3.2million

Wow! That’s a lot of tax that you can potentially be paying.

There are no ways to avoid all the taxes, but there are ways to defer and minimize part of them.

Let’s explore all the planning options to reduce these taxes in a different blog post.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

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