FIP507 Group Assignment NBB Case Study 3 and Questions Fall 2023 - Group 8

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Feb 20, 2024

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Group Assignment FIP 507 NBB Fall 2023 – Group 8 Riya Sanjay Parekh,166269217 Mohsin Saleem,115401226 Arjun Pareshbhai Patel,171196215 Aditi Jaswal,170575211 Shawn Doma, 138530233

Part 1: 16 marks 1. In your own words, what is an inter-vivos trust? (2 marks) An intеr-vivos or living trust is a legal arrangement established during one’s lifetime to hold assets on behalf of beneficiaries. In this type of trust, the assets are transferred into the trust by the settlor (in this case, Mr., and Mrs. Singh), managed by appointed trustееs (could be themselves or others), and intended to benefit the beneficiaries (their children, Hani and Gееta). The trust operates while the settler is alive and continues after their passing, providing a means to manage and distribute assets according to the terms set out in the trust dееd. 2. Why would putting the Rental Property into an inter-vivos trust be a good strategy in this case? (6 marks) The Singhs can use inter-vivos trust in many different ways to achieve their personal objectives, add flexibility to their estate planning, and benefit from financial and tax advantages during their lifetime. Some of the key reasons are explained below: a. Capital Gains Tax Deferral : The Singhs aim at deferring their capital gains tax and by transferring the Rental Property into an inter-vivos trust, the Singhs can potentially defer the capital gains tax. The trust structure allows for the avoidance of an immediate capital gains tax liability. As the family gets to enjoy the benefits of tax deferral, it will give them more control over when the capital gain tax is paid in future. It is crucial to note here that “to prevent indefinite postponement of tax on capital gains accrued on property in a trust, a disposition of trust assets is deemed to

occur every 21 years (referred to as the “21-year rule”), which results in taxes on the accrued capital gain. The tax can be delayed by transferring trust assets to the beneficiaries” (CIBC). It is important to plan for the finances to pay for taxes and most of the times it is difficult to huge amounts and then it acts as a burden, however, capital gains tax deferral will help the Singhs manage the burden of capital gains associated with their rental property. b. Reduction of Probate Fees : If the Singhs place the Rental Property in an inter-vivos trust, it can help the family to reduce the probate fees. Assets that are put in inter-vivos trusts generally do not go through the probate process, the value of the property is excluded from the calculation of probate fees. This will result in cost savings for the Singh family, and it will align with their goal of minimizing financial burdens associated with the rental property's transition to the children Hani and Geeta without worrying about the probate fees. c. Future Income Generation for Hani and Geeta : The Singhs' intention to pass down the Rental Property to their children is facilitated by the structure of an inter vivos trust. Trust can be designed to provide a steady income stream to the beneficiaries, Hani and Geeta, ensuring financial support for the next generation. Since the family wants a steady income for the children, inter vivos trust aligns with the family's objective to secure the property as a long-term income source for the next generation. d. Management of Family Dynamics : We understand that there is an existing issue in the family, specifically between Hani and Geeta. With the

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establishment of an inter-vivos trust, the complications in the relationships within the family can be addressed and accommodated properly. An inter vivos trust will provide a legal structure for managing and distributing the rental property's benefits among the beneficiaries, Hani and Geeta. The establishment of a trust will help clearly define the terms of the distribution of the income from the rental property without getting involved in the complications of managing and distributing the assets. This can also help address potential conflicts and ensure a fair distribution of income from the Rental Property among the children. e. Ease of Transition to the next generation : The structure and functioning of an inter vivos trust allows for a smoother transition of assets and income to the next generation. The Singhs are worried how the property will be transferred equally among their children but with the establishment of an inter vivos trust, they need not worry about these complications, ensuring continuity even in the event of death of one or both spouses. This also addresses the Singhs' concern about the potential burden of capital gains taxes at the death of the second spouse as an inter vivos trust will provide structured and tax-efficient means of passing on the property to the next generation while maintaining the relationships within the family. 3. Are there other options to consider (suggestion: answer this after reviewing both parts of this assignment)? There are alternative strategies the Singhs could consider addressing their concerns about capital gains and the transition of the rental property to their children:

a) Joint Ownership: They could explore jointly owning their property with their children. However, this could expose the property to the children’s potential creditors or legal issues, impacting the Singhs' original intention for this property. b) Will Planning: Establishing a clear and comprehensive will can dictate how the rental property is distributed after the Singhs' passing. However, this might not offer the immediate benefits and protections that a trust can provide during their lifetime. c) Life Insurance: The Singhs could consider investing in life insurance policies to cover potential tax liabilities upon their passing, ensuring that the children receive the full value of their property without having to sell it to cover taxes. d) Estate Freeze: This involves locking in the current value of the property for the Singhs and allowing any future appreciation to belong to the children. It involves complex tax planning and legal considerations. Each option has its advantages and drawbacks, and the Singhs should weigh them against their specific family dynamics and financial goals. Consulting with legal and financial advisors would be crucial to making an informed decision aligned with their objectives. 4. By proceeding with the transfer to an inter-vivos trust, what would be the taxable capital gain based on the ACB and FMV figures provided. Please keep in mind that the Singhs intend to use their matrimonial home as their principal residence, therefore for the purpose of this

example assume there is no option to have the Rental Property benefit from the principal residence exemption. (4 marks – for full marks show your work) Mr. and Mrs. Singh own (and live) in their principal residence in North York and own the rental property in Toronto. As it currently stands, by holding both properties, there are no capital gains – this would only be triggered upon sale of the rental or if both Mr. and Mrs. Singh were to pass away, prior to the sale/transfer of the property. However, in this situation, they are proceeding with transferring the rental to an inter-vivos trust. This decision (transferring of a property into inter-vivos), results in the trust effectively owning the rental property, while control and management are retained by the Singhs. However, there is a deemed disposition on the property, where the FMV (current value of the property) is determined and the ACB (purchase cost for the Singhs) is subtracted from this current value. The result is capital gain, however, only 50% of the capital gain is taxable. In our example, the FMV is $1,600,000, while the ACB is $500,000, which results in a capital gain of $1,100,000. The taxable capital gain would therefore be $550,000. Rental Property FMV of property $1,600,000 ACB of property $500,000 Capital Gain $1,100,000 Taxable Capital Gain (50%) $550,000 Bonus Question: If the sale of the Rental Property took place in tax year 1994 at the same FMV and ACB as indicated above, and the Singhs had never encountered Capital Gains prior, what, if any, would be the difference compared to question 4, in taxable capital gains on the disposition of the Rental

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Property? In order to get full marks please ensure you show and explain your work on this question. (2 marks) If the sale of the property took place in the tax year 1994, the Singhs would have been eligible to claim a lifetime capital gains exemption of $100,000. It was an exemption that was applied to capital properties, such as rental properties and cottages, which would allow you to shelter up to $100,000 of capital gains from income tax, over the course of your life. During this time, in 1990, the inclusion rate was increased from 66.7% to 75%, meaning that 75% of your capital gain was taxable. This was changed to its current form (50%) in 2000. As a result, there would be a change in the taxable capital gain calculated in question 4. The first part of the equation (determining the capital gain itself) would not change. It would still be $1,100,000. However, at that point, you would be able to apply the $100,000 capital gains exemption, which would reduce capital gains to $1,000,000. Then, we would calculate the remaining taxable capital gain on $1,000,000, which would be 75% of this value. Therefore, taxable capital gain would be $750,000, which would be $200,000 higher than without the capital gain exemption and with a higher inclusion rate. Rental Property FMV of property $1,600,000 ACB of property $500,000 Capital Gain $1,100,000 Capital Gain exemption $100,000 Revised Capital Gain $1,000,000 Taxable Capital Gain (75%) $750,000

Part 2: 14 Marks 1. Provide a summary of what the articles are discussing in your words. Describe the problem or problems as they relate to Mr. and Mrs. Singh and their Rental Property concerns. NOTE: imagine you are creating your own article from reading this article (and perhaps others). (5 marks) The first article discusses rental properties, and how adding them into estates makes matters complex. In this regard, an executor becomes the landlord who takes over all rights and responsibilities following the death of a property owner. The latter creates an imbalance between the fiduciary duties of the executor and the legal obligations towards tenants as far as value is concerned. For example, executors cannot just evict tenants to make a renovation or sale without adhering to specific tenancies laws (which differs per jurisdiction) and generally provide reasonable notice for tenants if any eviction is required. Executors also must consider any liabilities pertaining to the estate for not adhering to these rules could lead to penalties against the estate. The second article is concerned with taxes when one inherits a home or land. When you pass away in Canada, there is a ‘deemed disposition ‘of what a person owns. It is considered that the deceased sold such property on the day they died. Though a principal residence is excused from capital gains tax, this may still activate the same. Capital gains tax would probably apply for rental properties, however. In addition, there is a probate tax which differs among provinces but is not included in income taxes. The article also discusses the challenges associated with inheritance of property by the sibling, as each sibling incurs separate tax consequences depending on their stake. This

means that in managing a rental housing unit after an inheritance there are problems and possibilities comparable to the investments in stocks and bonds. These articles are quite crucial in that they offer guidelines on estate plans and management, which is relevant to Mr. and Mrs. Singh who are facing challenges concerning the sale of their rented property. In this regard, the Singhs should know that the tenants also have the law protecting them. Further, tenants cannot be evicted except for stated reasons. Individuals should also think about the income tax consequences of their legacy for rented property on income tax as well as probationary levies. This knowledge will enable them to be aware of the issues associated with their rent out policy thus they choose what is best for them in context to their rent out policies without violating any law or paying unnecessary fees. 2. Based on the article and any other information you have sought out (including your Text for this course) what are some potential pitfalls it appears that the Singhs have not taken into considerations that should be considered by them? (4 marks) a) Potential pitfalls that are based on tax, accounting, or legal concerns? b) Potential pitfalls that are based on family dynamics, priorities, rights of tenants, etc. a) Potential pitfalls based on Tax, Accounting or Legal Concerns: Tax of Trusts : If the Singhs transfer the property to a trust like an inter-vivos family trust, then there will be deemed disposition of rental property at fair market value at that time. If there has been an increase in value of the rental

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property from its purchase date, then there will be a taxable capital gain on this transfer. In addition, it must be considered that there will be a deemed disposition of the trust property every 21 years at its fair market value. This means that if the property ownership is still with the trust, then taxes will be payable on the accrued capital gain of the property. Therefore, potential issues like deemed dispositions and future tax on trust’s income may not be completely understood by the Singhs. Legal concerns : Another issue to consider about trust is the reporting requirements for trust starting with 31st December 2023 trust year-ends. This requires filling T3 tax return annually which will provide detailed disclosures of personal information of the settlor, trustees as well as the beneficiaries to the Canada Revenue Agency. (Gervais) Cost of Trust Administration : Trusts are expensive to maintain or establish. Setting up a trust involves recurring administrative costs like tax preparation fees, trustee fees, as well as legal fees. These costs should be considered by the Singhs. Need for comprehensive Estate Planning : The main goal of estate planning is ensuring that the client’s final wishes are carried out in a tax efficient manner, and the estate’s value is maximized. A comprehensive estate plan includes a will, naming beneficiaries, choosing a power of attorney as well as setting up a trust. (IG Wealth Management) Therefore, transferring rental property to the trust is only a part of the estate plan but it is not a comprehensive estate plan. The Singhs should consider

setting up a comprehensive will, naming beneficiaries for assets that are the part of estate as well as choosing a power of attorney. b) Potential pitfalls that are based on family dynamics, priorities, rights of tenants, etc. Family Dynamics: The existing tension between Hani and Geeta should be considered by the Singhs to ensure that the situation does not get exacerbated. This tension should be addressed by the Singhs, and they should have a discussion with their children about how they would share the rental property so that there is no conflict regarding their share after the rental property is transferred. Priorities: Priorities of children should be considered by the Singhs. It is evident that Hani is frustrated with the maintenance requirements of the rental property. It is advisable to have an open conversation with children about the rental property and its maintenance requirements so that their children can comfortably manage the rental property. This would avoid any future disagreements about the responsibilities related to rental property that are to be fulfilled by each of their children. This is also important as even after the property is transferred to the trust, property maintenance costs might still have to be incurred by the beneficiaries. Rights of Tenants: Rights of current tenants should be considered if they would continue renting the property while it is being transferred to the trust. This is important as the transfer of rental property to a trust may require changes in the lease agreement.

3. Knowing how attached the Singhs appear to be to the idea of their children continuing to own their Rental Property, provide a game plan for how you plan approach what may be unwelcome but very important points to consider, before making decisions about how the Rental Property will be dealt with in the future. What will you say to them? What would you do if they said they would rather not discuss your concerns? (4 marks) Client objections are frequently encountered by financial advisors when it comes to discussing potentially unfavorable courses of action. However, these objections can be overcome by effectively providing clients with appropriate information presented in a suitable manner. Encountering resistance from clients is an integral aspect of the change process. It is important to establish a connection with the client and engage them in meaningful discussions. (Horwitz) To address unwelcome yet significant points that need consideration for the Singhs, we would suggest the following strategic plan: We would adopt an understanding and empathetic approach in dealing with the Singhs. This would help us build a strong connection with them as they will feel that we understand their concerns. Showing empathy in interactions with clients can be a very helpful way to deal with a client’s concerns and resistance to change. Followed by this, we would discuss with the Singhs the significance of comprehensive evaluation of all the implications of any decision. We will explain to them the potential risks that they may face because of their decision.

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Furthermore, we would explain to them that evaluating the positives and negatives of any decision is essential for preventing the risk of any consequences in the future. And this approach will certainly be in their best interest. We would assure them that their final choices and decisions will always be respected. We would share with them the factors that they should take into consideration. Some of these considerations are: Family Dynamics: There is tension between Hani and Geeta. The impact of any decision on family relationships should be considered. Management of Rental Property: Hani is frustrated with the management requirements of the rental property. Therefore, the concerns related to maintenance requirements of the rental property should be considered when taking a decision. We would then share with them the alternative strategies that would be a suitable option for them. We would provide them with information on different trust structures that would be better suited for them in terms of their family dynamics as well as the tax situation. If they still do not want to discuss it, then we would assure them that we respect their decision. Moreover, we would explain to them that the reason for recommending a comprehensive evaluation was to ensure that they make informed choices by considering all the facts. Finally, we would document the agreed points and would seek written confirmation from the client to proceed with their selected choices.

Documentation helps in providing a useful reference point for the actions to be taken. Overall, the plan would be to explain the potential implications to the Singhs and then if they still want to proceed with their decision then we would assure them that we respect and value their decision. 4. What did you learn from completing this assignment? (1 mark) This assignment offers insight into inter-vivos trusts, which is a term used for a will that offers instructions on how property passes after death. This explains the best way the trusts are used to estate planning, as well as asset management on behalf of the settlers, provided that they are alive. Specifically, the assignment emphasizes the need for a strategic estate plan especially dealing with the rental properties. This reveals that strategies such as a living trust can help in areas such as tax saving, control, asset protection and avoidance of probate. It identifies the various tax implications that must be considered while planning an estate, such as the treatment of capital gains, probate fees, and the differences between various trusts or other forms of estate planning methods. The task involves a detailed study, among which is reading articles and legal documents.

Works Cited CIBC. In trusts we trust: Tax and estate planning using inter vivos trusts. July 2023. https://www.cibc.com/content/dam/personal_banking/advice_centre/protect-whats- important/in-trusts-we-trust-en.pdf . Gervais, Rachel. “Succession planning for the family cottage”, BDO, 30 Oct. 2023, https://www.bdo.ca/insights/family-cottage-succession-planning IG Wealth Management. “What is estate planning? Hint: it’s a lot more than just making a will”. IG, 1 March 2023, https://www.ig.ca/en/insights/what-is-estate-planning Horwitz, Edward. “Understanding and Dealing with Client Resistance to Change”. Financial planning association, 1 Nov. 2013, https://www.financialplanningassociation.org/article/journal/NOV13- understanding-and-dealing-client-resistance-change-0

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