When considering their estate planning, parents often want to support their children financially but are not sure of the best way to do so. One option of sharing wealth is to provide a gift. A gift is defined as a voluntary transfer of property to another without consideration (i.e. receiving anything in return). The essential elements of a gift are:
- Capacity of a donor to make the gift;
- Intention of the donor to make a gift;
- Completed delivery of the subject matter of the gift to or for the recipient; and
- Acceptance of the gift by the recipient.
For our purposes, there are two main types of gifts: the first is an “inter vivos” gift, which is given during your lifetime. The second is a “testamentary” gift, which is given upon death in a person’s Will. Regardless of the type of gift chosen, parents need to carefully consider the potential tax and family law implications that are associated with making a gift. There are a number of planning tools that, if properly utilized, can be used avoid future problems.
Tax Implications
Inter vivos Gifts
For income tax purposes, an inter vivos gift of capital property with no consideration is treated as a disposition of the property at fair market value, and thus any accrued capital gain or loss on the property will be payable by the transferor (the parent) when they make a gift. The cost base of the recipient of the gift (the child) will also be the fair market value of the property, and thus any future gains will be taxable in the recipient’s hands.
For example, if a parent wishes to gift an investment portfolio that has a fair market value of $500,000 and an adjusted cost base to the parent of $250,000, then the parent transferor will have to report a capital gain of $250,000 in the tax year in which the gift was made and pay tax on 50% of such gain. The child transferee’s adjusted cost base of the investment portfolio going forward would be $500,000.
Extra precaution should be taken when asking a child to pay partial consideration for capital property. For example, if the child above paid the parent $250,000 for the investment portfolio, the parent will still be treated as though he or she sold the portfolio for its fair market value ($500,000). The difference is, that instead of the child having an adjusted cost base of $500,000, his or her adjusted cost base would be $250,000 (the amount paid to the parent).
Testamentary Gifts
A testamentary gift is given upon death through a Will. Immediately upon death you are deemed to have sold all of your capital property for its fair market value. Assuming your spouse is not a beneficiary of your estate, there would be a similar calculation of capital gains and the tax would have to be paid by your estate before any assets are distributed to your beneficiaries (i.e your children). Your children would receive the gift “tax-free” because tax will have already been paid by your estate.
Generally speaking, the tax triggered on death is not only the last tax bill of the deceased, but is often the biggest. This is because all of the deceased’s accrued gains are triggered at once and may be taxed at higher marginal rates than in years past. If an individual has sufficient savings and income, he or she may wish to trigger capital gains in later years at a time when they are paying tax at a low marginal rate, either by selling capital property with accrued gains or by gifting to children. Anecdotally, this latter option has the added benefit of watching your children enjoy their inheritance.
Family Law Implications
When property is gifted to an adult child, the gift can become exposed to marital claims in the event of a marriage breakdown or a claim against the estate of a deceased spouse. The principal amount of an inter vivos/testamentary gift and inheritance to a spouse would be considered excluded property under subsection 85(1) of the Family Law Act. However, any increase in the value of the excluded assets would become family property. Further, if the gift becomes comingled with family property it may lose its protection as excluded property. For example, if the owner spouse transfers the property to the other spouse or into the joint names of the spouses.
Planning Tools
There are a number of steps you can take to protect yourself and ensure your intentions are preserved when providing a gift to your child.
- You can encourage your child to have a marriage or cohabitation agreement that specifically states how gifts and inheritances will be treated upon separation.
- You can properly document your intentions when giving amounts to your children. If your intention is to loan an amount to your children then you should have your child sign a promissory note or a loan agreement. If you loaned money to assist your child and their spouse to purchase a property, then consider putting a mortgage on the property. Alternatively, and depending on the nature of the property, a Deed of Gift can be used if you intend to make a gift of funds.
- You can also consider setting up an inter vivos or testamentary trust. An inter vivos trust is created during your lifetime whereas a testamentary trust is created in your will and takes effect upon your death. An inter vivos trust can serve as long-term income and protection for minor children, be used in tax planning by providing a reduction of probate taxes and protect trust assets from marital claims. A testamentary trust can similarly be used to control the timing and distribution of assets to beneficiaries and provide for minor children and protection against creditors. Gifting to children by way of a trust allows the children to have benefits from the property while also allowing you to maintain some control of the property.
Gifting to children may seem like a simple process, but as explained above, it can have unintended legal consequences. This is why is it important to seek legal advice and discuss appropriate planning tools with a professional advisor before gifting property to your children.