The dos and don'ts of tax-free gifts in Canada
If you’ve ever considered making a significant financial gift to your children, you’re not alone. A recent CIBC poll of 3,021 randomly selected Canadian adults found that the majority (76 per cent) of Canadian parents with a child 18 years or older would give their kids a financial boost to help them move out, get married, or move in with a partner.
Once you decide to give, however, the next question is how much should you give, what form should your gift take and what are the tax, and in some cases, family law considerations and opportunities associated with making a gift.
For starters, cash is probably the most common way gifts are made but you may also consider making a gift of property “in-kind” such as, perhaps, a gift of securities from your account to your child’s account or a gift of real estate to your kids.
Canada generally has no rules limiting how much you can give, either in your lifetime or upon death and while you can give as much as you wish, be sure to only give only amounts that you are certain you won’t need to support your own lifestyle and goals. After all, the biggest problem with making a gift is that it can be difficult to get it back later so best to avoid depleting funds that you may need for yourself (and your spouse or partner) during your lifetime.
There are two main types of gifts: “inter-vivos” gifts, meaning gifts made during your lifetime, or “testamentary” gifts which are given upon death. By making gifts during your lifetime, you will often be able to see your beneficiaries enjoying your gifts and there may even be opportunities for tax savings.
The poll found that many Canadians were confused about the taxes associated with making a gift, with over half admitting they simply didn’t know what taxes exist on a financial gift to a child or relative, while nearly 10 per cent believed that the gifts were potentially taxable to the recipient.
While gifts themselves are, indeed, received tax-free, it is important to keep in mind that there can be taxes arising depending on what is given away. When you make a gift of assets “in-kind,” such as appreciated securities or real estate, you will generally be treated as if you have sold the gifted property at fair market value and you will pay tax on 50 per cent of capital gains.
There are, however, some exceptions to this rule. For example, if you make an in-kind gift to your spouse or common-law partner, there is an automatic “rollover” at the property’s tax cost or adjusted cost base (ACB). This provides a deferral of tax on any accrued capital gain to the date of the gift, although, under the spousal attribution rule to prevent income splitting, you will pay tax on any capital gain when the property is ultimately sold by your spouse or common-law partner. You will also continue to be responsible for the tax on any future income earned on the gifted property.
While gift recipients won’t pay any income tax on the gifts they receive, a recipient of your gift will pay tax on any future income that is earned on the gifted funds, which may provide opportunities to income split and save tax for many years to come.
For example, suppose you pay tax at a marginal rate of 50 per cent and your adult daughter pays tax at a marginal rate of 20 per cent. If you make a gift to your adult daughter of $100,000 and she invests the funds to earn 5 per cent income annually, the overall tax savings for your family each year could be $1,500: $100,000 x 5 per cent x (50 per cent – 20 per cent).
Note that the new anti-income sprinkling rules introduced last week by Finance Minister Bill Morneau do not affect this type of tax planning where a bona fide gift is made from a parent to someone over the age of 18. The new rules, which are aimed at various income sprinkling strategies done via a private corporation, apply even to adult relatives, such as siblings, children, uncles, aunts, or nieces and nephews.
Gifting may also save you some taxes upon death as most provinces levy an estate administration tax or probate fee of up to 1.7 per cent of the assets in your estate (depending on your province). This could decrease the amount available to your beneficiaries. By gifting assets before you die, these assets will not be subject to probate fees because they will not be part of your estate.
When you transfer property directly to the recipient, you usually lose control over how the recipient uses property. If you want to maintain some measure of control regarding the use of funds after you make the gift, you could consider establishing a trust.
To create a trust, you could transfer assets to a trustee who will manage the assets on behalf of the ultimate recipients (beneficiaries). Through the trust agreement, you may specify timing and amount of distributions to beneficiaries, which may be particularly useful for spendthrift or incapacitated beneficiaries, who may not have the responsibility or capacity to manage funds themselves. Use of a trust is more complex than an outright gift and you should definitely seek the advice of a lawyer who specializes in trusts to determine if a trust is right for you.
In some cases, a trust may also help to protect the gifted amount from creditor or spousal claims against gift recipients, as could taking back a promissory note that is payable on demand. Indeed a common strategy when parents want to help a child purchase a home but wish to protect those funds in case of marital breakdown is for the parents to structure the “gift” as a loan, secured by a non-interest bearing mortgage on the property. This mortgage can then be forgiven at some later date or even upon death, if desired.