QUESTION:
What are the tax considerations of transferring real estate to my adult child and then renting it back from them?
ANSWER:
There are a number of reasons why a parent may consider transferring real estate to an adult child and then renting it back from them. Gifting the property can help reduce the value of your estate, minimizing estate taxes (which can be particularly important if the real estate is part of a large estate that would otherwise face significant probate fees), and lock in current fair market value (FMV) for capital gains. Transferring the property in advance may also simplify the estate planning process by expediting the transfer of assets upon your passing and reduce the likelihood of disputes.
Renting the property back from your child after transfer may provide them with additional income, or perhaps you just want to continue using the property while ensuring it stays within the family.
These are all legitimate potential benefits, but there are also some potential drawbacks to consider:
Capital Gains Tax and Fair Market Value
Gifts are not taxable in Canada, but if you transfer property to a family member (other than your spouse or common-law partner), the transfer will be deemed to have taken place at FMV even if no money changed hands.
If the property being transferred is not your principal residence, you (as the giver of the property) will be subject to capital gains tax on any appreciation in value from the time you acquired it until the time you gifted it. This tax can be substantial. Canadian taxpayers are currently required to pay tax on 50% of all capital gains realized in a tax year. As of June 25, 2024, based on proposed legislation, this will increase to 50% on capital gains up to $250,000, and approximately 66.67% on capital gains over $250,000.
If the property in question is your principal residence, you will not be subject to capital gains tax on the transfer—as the principal residence exemption allows for the tax-free sale (or deemed sale) of a qualifying home—but you would still need to report the disposition on your tax return.
If your child currently lives at a property that is not your principle residence but is held in your name, and you want to transfer title to them, you may still be able to claim the principle residence exemption and transfer the property tax-free, as the CRA states a principal residence is one that “must be ordinarily inhabited in the year by the taxpayer or by his or her spouse or common-law partner, former spouse or common-law partner, or child.” But it is important to note that this would negate your ability to claim the principle residence exemption your own home during the same period.
Note: If you sell the property to your child for less than FMV, the CRA will treat the sale as if it occurred at FMV. This means you will still need to report any capital gains based on the property’s FMV, not the amount your child paid.
Taxable Rental Income
Once your child owns the property and rents it back to you, they will need to report the rental income on their personal tax return. Although they may be able to deduct expenses that they paid related to the property, such as property taxes, insurance, repairs, and mortgage interest (if applicable) as well reasonable expenses they incurred to earn the rental income, such as utilities, maintenance, and property management fees,
the rent they receive may bump them into a higher tax bracket, depending on their total income for the year. Renting from your child could also impact their eligibility for certain government benefits.
Note: To claim rental expenses and losses, the CRA requires a reasonable expectation of profit. If the rent is significantly below FMV, the CRA may view it as a cost-sharing arrangement rather than a true rental situation.
Principal Residence Exemption for the Child
If the child does not use the property as their principal residence after the transfer and rents it to you instead, they will not be able to claim the Principal Residence Exemption on the property for this period. As a result, any appreciation in the property’s value from the time of the transfer will be subject to capital gains tax if and when the child sells the property. If your child eventually moves into the property and makes it their principal residence, they may qualify for the Principal Residence Exemption on a portion of the gains based on the period they lived in the home.
Land Transfer Tax (LTT)
In most provinces, the transfer of real estate from a parent to a child will trigger land transfer tax based on the FMV of the property at the time of transfer, regardless of whether money is exchanged or the property is gifted. This tax would be payable by your child when they take ownership of the property.
The LTT rates in Ontario are currently:
-
- 0.5% on the first $55,000 of the FMV.
- 1.0% on the amount exceeding $55,000 up to $250,000.
- 1.5% on the amount exceeding $250,000 up to $400,000.
- 2.0% on the amount exceeding $400,000.
- 2.5% on the amount exceeding $2,000,000 (for one or two single-family residences).
Additionally, if the property is located in Toronto, a Municipal Land Transfer Tax (MLTT) will also apply, which basically doubles the LTT.
Note: A formal property appraisal may be required to establish the FMV of the property at the time of transfer, which will be used for calculating capital gains and land transfer taxes.
Other Considerations
Transferring property to an adult child may also lead to legal complications if they are married or plan to marry. If the property serves as a family home, it may be classified as a marital asset, and subject to division unless specified in a marriage contract. If the intent is to gift the entire property value, properly registering a mortgage for the full fair market value at 0% interest may safeguard the asset in the event of divorce.
Once the property is transferred, you lose legal ownership, which may create potential conflicts if disagreements occur regarding property usage or management, or if your child faces financial issues and decides to sell or lease the property against your wishes. An equal consideration would be that the equity in the property would no longer be available to you if your own financial position changes.
Alternate Strategies
The tax implications of transferring property to your child can be significant, especially if the property is valuable. A key consideration is whether the transfer fits within an overall estate plan or if alternative strategies might be more tax-efficient.
By transferring the property into a trust instead of directly to the child, you can maintain control over the asset while benefiting from tax planning advantages. A trust can also provide protection from family law issues and creditors. In some cases, a family trust can defer capital gains taxes until the property is sold by the trust or distributed to beneficiaries. A trust can also facilitate income splitting, where rental income from the property is distributed to beneficiaries, who may be taxed at lower rates than the high-net-worth parent.
Note: The Principal Residence Exemption would not be available if the property is held by a trust.
Some people use family limited partnerships (FLPs) to transfer real estate while maintaining control over the asset. FLPs can provide estate planning benefits and allow for the gradual transfer of wealth to children, helping to minimize capital gains taxes over time.
S+C Partners is here to help
Transferring real estate to an adult child comes with several tax implications. Consulting with an experienced professional is strongly recommended to help minimize the tax burden for both parties. Our dedicated tax team and fully qualified and experienced Trust and Estate Practitioners are here to support you. Please call us at 905-821-9215 or email us at info@scpllp.com if you have any questions or require any assistance.
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