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Housing prices have been climbing quickly. This is especially true in major urban centres where most Canadians live. The rate of increase for the average sale price appears to be climbing faster than people are able to save.
Some Canadians see the dream of homeownership vanishing, others wonder if the choice to own is appropriate for them. No matter the situation, objective analysis should accompany the emotional aspects of buying a home.
What You Need to Know
Regardless of the ultimate choice, affordability is an important decision criterium. No one has ever enjoyed being “house poor”, where little money is left after making your rental or mortgage payment. Based on household income and available down payment a maximum purchase price can be determined.
Every Canadian financial institution has an online calculator to determine mortgage payments. Mortgage providers employ additional analysis tools to predict whether a borrower will repay the lender based on their income, total expenses and financial history. If lenders are reluctant or refusing to provide a mortgage, perhaps the timing is not appropriate, yet.
Mortgage rates have been at the extreme low end of their range for several years as central banks around the world have attempted to revive economies through inexpensive borrowing. When interest rates are low more people and businesses can afford to borrow more. When something is on-sale people buy more, but for borrowing, you cannot decide to delay a purchase when prices rise. Payments must still be made.
At some point rates will rise and some homeowners may not be able to afford their new, higher payments. Before buying their first home, borrowers should ask themselves, “if mortgage rates rose by 2%, would I be still able to afford my payments?”. For example, a $400,000 loan with an additional 2% interest adds $8,000 interest charges per year, or $667 more each month.
That increase would sit atop the existing mortgage payment. The same $400,000 mortgage with a 25-year amortization and 2.25% 5-year fixed rate requires a monthly payment of $1,750. Each additional $100,000 adds another $450 per month to the payment.
Lenders typically limit housing costs to 35% of gross income, acquiring a mortgage will ultimately decide if you purchase and the price. If you earn $100,000 then your maximum housing costs are $35,000 per year. Subtracting property taxes, condo fees and utilities will determine the amount available for mortgage payments. If these costs totaled $14,000, then a maximum of $21,000 would remain for mortgage payments. $21,000 divided by 12 equals $1,750 per month, yielding your maximum mortgage of $400,000.
A down payment is also required; the more the better. At least 10%, but 20% is preferred to keep payments lower. In the examples above with a $400,000 mortgage a first-time home buyer should plan on a down payment of at least $50,000 netting a purchase price of $450,000.
An experiment to determine if home ownership is appropriate is to act as a homeowner while renting. That is, make housing costs equal 35% of gross income. Set aside exactly 35% each month, pay your rent and utilities and the rest goes directly into a savings account, an RRSP or TFSA. Set up the deposit like a monthly bill that is paid automatically. If you are able to practice this disciplined spending/saving approach you are able to live at 35%, if not habits may need to be changed or a more modest home purchase should be contemplated.
Continuing the example of $100,000 income, then $35,000 per year or $2,920 should go toward rent, utilities and savings. If rent is $1,800 and utilities are $150 set up an auto-deposit for $970 each month. At the end of one year, you will have nearly $12,000 more set aside. At the very least this test should increase the amount of your down payment.
While you are accumulating your down payment the type of investments you purchase and sheltering it from taxes is also important. First time homebuyers can withdraw funds from their RRSPs, for example. Certain conditions apply, of course.
The Bottom Line
A dangerous emotion during a period of rapid rises in house prices is desperation. “If we don’t buy now, we’ll never be able to afford a home” has led many to overextend themselves financially. After that has occurred owning again can be almost impossible.
Couple the dreams of home ownership with objective analysis to determine the best course of action. Prudently investing your down payment in a tax advantaged way is another important aspect of the home buying and ownership experience. We are happy to help with calculations, scenarios, timing, negotiation advice with lenders and investment recommendations.
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The view about high-net-worth people is they probably have too much and don’t bother about taxes. This couldn’t be farther from the truth. HNW people are just like everyday people. They bleed cash like every other regular Canadian. High net worth people are also entitled to tax benefits on their money just like every other Canadian. As a high-net-worth individual who moves financial assets from one place to the other, it is important to maximize whatever tax benefit is available to you to save funds. In this article, we will discuss key tax matters and best practices that you must be wary of when dealing with friends and family. These three matters include: property gifts, having a secondary residence, and personal loans to friends and families.
1. Tax Implications of Real Estate Property Gifts
Real estate is becoming increasingly expensive in Canada. If you have the privilege of owning some real estate properties and thinking of gifting them to your loved ones, there are things you must consider.
Capital Gains Attribution – This is one thing you should be wary of when gifting a real estate property in Canada. For a better understanding, let us look at this example: If you gift a property to your spouse and they decide to sell to a third party, any capital gain or loss on the value of the property will be charged back to you. In other words, any profit or loss made on a property you gifted to your loved one will be attributed as yours and taxed accordingly. This is known as Tax-free rollover. It is an automatic tax charge on income from a property gifted to a spouse. To avoid this, you must apply to opt-out of the automatic tax-free rollover. When you apply, it means that you will have to report any accrued gains on the property and your spouse will also report any future gains on the property. The exception to this is when the property is gifted to a minor. You are not allowed to opt-out when you gift the property to a minor.
Income Attribution – Income attribution in Canada has to do with income from real estate properties. This occurs especially when you gift a property to your underaged family member. It could be your child, or a nephew or niece. If the child is under 18, any income on the property will accrue to you and will be taxed. This means that you will carry the tax burden of the income on the property gifted until such minor clocks 18 years of age. The income referred to in this type of attribution means rental income. It is different from capital gains attribution. Income attribution also applies to spousal gifting of property or a common-law spouse. Any income accrued on the property will accrue to you and will be taxed accordingly. In all of this, it does not matter if you spend out of the profit or not; if it is a gift coming from you to your spouse or an underaged loved one and it will be assumed that the income is going to you.
Double Taxation on Transfer of Real Estate Property – Double taxation on real estate property gifts may occur when you transfer your property to a family member for less than the fair market value of such property. For a better understanding, let us use an example where you sell a real estate property to your son at a value of $20,000 as against the fair market value which is $350,000. In this type of situation, it will be deemed that you made a proceed of $350,000 on the property. Your capital gains, in this case, will be $320,000 ($350,000 – $20,000). Half of the $320,000 will be subject to tax. If your son goes ahead to sell the property for the fair market value of $350,000, you will be taxed on this sale again. This then amounts to double taxation. Another example of when double taxation can occur is when you sell your property to a loved one at a value more than the fair market value. For example, if the property is valued at $300,000 and you sell it to your sister at $350,000, it will be deemed that you made a proceed of $350,000 on the property and taxed accordingly, but it will be deemed that the property cost your sister $300,000. If your sister decides to sell the property in future, you will be taxed again. Fortunately, there is a way out. The reason for the double taxation in the scenarios painted above is that the property was sold for a value. However, if you transfer the property for no consideration at all, it will be deemed that it was sold at a fair market value. The beneficiary will have a fair market cost base which will allow you to avoid double taxation.
What Are Your Alternatives? With all the taxes mentioned above, it is advisable that real estate properties should not be transferred for a lower amount from the fair market value. But if you want to transfer your property to your loved ones without any consideration to find a way around Capital gains attribution and income attribution, you can consider any of the following:
- You can gift your loved one the cash they need to acquire the money at a fair market value. That way, you will not be taxed on capital gains or income from the property.
- The other option you have is to lend your loved one the money required to purchase the property at a fair market value. However, you must ensure that they pay a prescribed interest rate on the loan. – The full loan must be repaid on or before the 30th of January the following year and it must include the interest income in your tax return.
2. Best Practice Personal Loans to Friends & Family
Being a high-net-worth individual may mean that people come to you from time to time to get loans. It is a privilege to be able to help others, but you must ensure you do it with your eyes wide open so as not to regret it later. For one, the reason most people turn to private loans from friends and family is that banks have rejected them, and they believe they will get flexible terms. This makes lending money to friends and family a risky venture.
Here are some best practices to guide you on what you need to protect yourself:
Choose Wisely – People have different reasons for needing a loan without a thought as to how they will repay the loan. Some reasons are more worth it than others. Therefore, it is important to know the reason for the loan before giving it. The reason for the loan will probably tell you what you need to know about the person. They may be your friends and family but it is your money, and the final decision is yours. Here are some genuine reasons you can consider lending money:
- A start-up business or an existing one. Investing in a business could yield returns afterwards.
- Down payment for a new home. You can consider helping in this regard.
- Medical needs. This is another genuine reason for which you can lend money.
- Divorce and legal problems are also genuine reasons someone may want to borrow money.
- If the person just relocated, you could consider lending him/her some money.
It is also important that every detail of the loan should be discussed. Being a friend or family is not enough. There should be a repayment plan and an agreed interest rate. All these terms should be clear and should be in writing if possible or there should be a witness to the discussion.
Have A Plan – It is important to have a plan with the person you are lending money to. Some of the things to be discussed include:
The Type of Credit Arrangement – It is very important to be clear whether it is a loan, or you are co-signing on a loan already borrowed. Both are risky but co-signing may be riskier because you are placing liability on yourself to repay if the person defaults. This may affect your credit score. Meanwhile, a loan coming from you bears a lighter risk because if the person does not pay it back, you must be prepared for that eventuality. Be clear on the difference and make sure you make the best decision.
Be Clear on Interest Rate – This is a tricky subject for friends and family who want to enter into a loan agreement. On the one hand, you as a lender will want to make sure you give a favourable interest rate, especially with the risk involved. The borrower, on the other hand will be expectant that you give an interest rate that will be favourable to him or no interest rate at all, considering the relationship between you two. Whatever the case may be, it is important that you are clear on this condition. You can give a lower interest rate than banks but high enough to ensure you make money from the transaction rather than your money just lying in the bank.
Get It Documented – This is an important step that could make or mar your relationship with the borrower. Money can be a tricky issue which can give room for recriminations. To avoid this, it is important to get everything discussed, especially the terms agreed upon by both parties’ documents. The amount, interest rate, repayment dates, and the penalty for late repayment. There are free online resources that provide templates you can use for the contract to be signed by both parties. This makes them facts and legally binding on both parties regardless of the relationship between you two.
Payment Arrangement – The payment agreement is an important part of the contract. It is important to agree on when and how the loan will be paid. All these should be written in clear terms in the contract drawn up. Loaning money to family and friends can be tricky. It is important to adhere to the tips mentioned to preserve your relationship with the person.
3. Tax Implications for Secondary Residences
It is not uncommon for high-net-worth individuals to have an additional shelter as part of their assets. it could be a vacation home or an investment. The fact remains that it is your asset and will be referred to as a secondary residence. Usually, a residence that is being habited is regarded as a primary residence. The CRA requires that you report a sale of your primary residence to qualify for the Principal Residence Exemption (PRE). The CRA will analyze your data before granting you a PRE. Details that are assessed include the duration you have been living in the said residence, your real estate investments, and your sources of income. All of these will help them determine if the building is truly your primary place of residence. This exemption does not apply to your secondary residence.
To save yourself some cash on taxes, if you have a secondary residence and you have a spouse or a common-law partner, you can designate the secondary residence to your spouse for all the years you own and use it as a primary residence which qualifies it for capital gains tax exemption when it is sold. Fortunately, the Canada Revenue Agency (CRA) does not prescribe how long you must live in a house for it to become your primary residence. It only says that you must habit the residence for a short period which makes it open to interpretation. Residences outside Canada can also be designated as a primary residence if the designate has inhabited the home in the year in which the PRE is being applied for. If you fail to take advantage of this, your secondary residence will be subject to capital gains tax for the years it was not designated to an inhabitant.
When designating, there are exceptions you need to take note of. The first is that only one property per year and per family can be designated as a primary residence. A family member in this context means your spouse or common-law partner and your children that are under 18. Another exception is that any residence that is above 1.2 acres in size will not qualify for PRE except if you are able to prove that the excess land is required for the use and enjoyment of the residence. This means that the excess land will be subject to capital gains tax.
For a maximum tax advantage, you should designate the residence with the highest average capital gains per year. You can also contact a tax expert for proper guidance.
Although it seems like a lot to digest, that is why you have an advisor. Reach out with any questions in any of the above areas if you feel in over your head.
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Divorce is an emotionally draining time for not only the couple but for their family as well. It can also be a financially devastating time. Putting your energy into your financial wellbeing is essential when going through this big life transition. You will be forced to make life changing decisions in a very short period, and it is important that you know what you are entitled to and where you stand in the marriage, from a financial perspective.
What You Need to Know
- Find and Compile Your Financial Records – Your first move to protect yourself financially is to make a file of all your financial records. Tax returns, loan documents, retirement accounts, bank accounts, and investment statements. You want to be sure that you are aware of all accounts and liabilities when you go into the divorce process.
- Assess Your Assets – Make an exhaustive list of all your assets that could come into question when it comes to division of property. Marital assets are any asset or liability that was acquired during the marriage. This includes houses, cottages, land, investments, pensions, personal property (jewelry, art etc.), vehicles, and other types of intangible property (such as intellectual properties). Debts can also be considered marital property depending on the nature of the liability. Typically, assets acquired before marriage remain in the possession of the person who brought them into the marriage. Inheritance and gifts can also be excluded from divorce if the assets have not been used to buy joint property.
- Open New Bank Accounts – Many married couples have combined finances and use joint bank accounts for convenience’s sake. If you have or if you plan to end your marriage, one of your first steps should be to open new bank accounts in your name that your spouse does not have access to. You should also make it a priority to have any direct deposits updates with your new accounts (your pay cheque, for example) and start paying your bills out of your new individual account.
- Change Your Will and Update Beneficiaries – Most couples name each other as beneficiaries in their will and on any investment or insurance accounts that beneficiaries are designated. This should be changed as soon as possible. This may not seem like a top priority, but the unexpected happens and no matter how amicable the divorce, it is impossible to know your wishes will be honors upon your death if you do not put it in writing. Investment accounts and life insurance policies can easily have their beneficiaries changed through your advisor. Your will and power of attorney designations needs to be updated by a lawyer.
- Change your Mailing Address (if applicable) – If you are changing your address due to the divorce, or even if you are splitting time in the family home until the divorce is settled, you should change your mailing address immediately. Whether this is to your new home or if you secure a PO Box, it is important that your mail stay private as you may receive correspondence from your lawyer or information about your finances that your former spouse should not be privy too.
- Get Credit Cards in Your Name – If you have joint credit card, pay them down and cancel them immediately so that you don’t find yourself responsible for debt that your spouse may accumulate when you leave the marriage.
- Refrain from Making Any Big Financial Decisions – Divorce can be a long road. Assets may become unavailable to you as you go through court proceedings, or conversely you could end up having to hand over more to your spouse then planned, and it is wise to hold off any making any big purchases or making any irreversible decisions until the divorce is finalized.
The Bottom Line
Divorce is complicated and can be a difficult time, both emotionally and financially. It is always best to work with legal and financial professionals when navigating a divorce to ensure your best interests are being looked out for and that you are being treated fairly as the divorce proceeds.
A retirement savings plan is a way of protecting your post-retirement financial lifestyle. However, in recent times, recessions, stock-market declines, housing market bubbles, joblessness, and, most recently, a global pandemic have created a series of challenges for people trying to start, grow, or maintain a retirement savings plan. With all the economic uncertainties, it’s natural to wonder if you’re doing all you can to protect your retirement nest egg. Taking a back to basics approach can instruct you on how to keep your retirement financial plan on track during uncertain economic times and beyond.
Consider these tried and tested tips that most financial advisors will recommend for a secure and enjoyable retirement.
- Make Realistic Budget and Lifestyle – Determining your retirement income needs starts with making realistic assumptions about your future. Because of increased life expectancy, retirement years are longer than they used to be. The average Canadian is expected to live to 78.79 years. Longevity can also be impacted by genetics, where you live, your marital status, and your lifestyle. All of these factors into how you plan for your retirement. It’s also good to be realistic about your post-retirement budget and lifestyle. Do not make the mistake of assuming that your post-retirement budget will be reduced. Retirement is becoming increasingly expensive, particularly in the first few years. It’s essential to have a plan to help mitigate expenses when you are no longer earning a paycheck.
- Have A Savings Plan – Based on these realistic lifestyle assumptions about your post-retirement days, you can begin to determine what you can do now to sustain yourself financially for at least 25 years post-retirement. The 4% rule is one popular method for working this out. In this model, you commit 4% of your savings for every year of retirement. Another approach is to draw down 2-3% of your total retirement portfolio annually, adjusted yearly for inflation.
- Consider Inflation – Speaking of inflation, failing to factor it into your plan could take a substantial bite out of your hard-earned nest egg. Inflation impacts how much your retirement savings will be worth over time, so understanding this is critical to ensuring that you have enough assets to last throughout your retirement.
- Grow Your Retirement Savings – Retirement means different things to different people, but the key is to enjoy this time of your life while making sure you don’t outlive your retirement savings. You are more likely to achieve this with a thoughtfully developed plan that allows you to withdraw money from your portfolio while enabling growth over the longer term. You can achieve this by using various investment vehicles with reasonable returns.
Planning for the future is a complex and sometimes emotional process that is not easy to do without guidance. Financial advisors can help you remain objective and focused on your future goals. They also have the skills and tools you need to plan for a healthy financial future.
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