The Federal Budget 2015 had so many interesting and significant changes for real estate investors that we are following up with Part II of our series to further discuss it.
In our last article in the July issue of the REIN Report, we talked about the proposed changes relating to corporate tax rate decreases for small business owners earning “active business income”, increases to the taxes on dividends for long-term real estate investors, large changes for donations that real estate investors can take advantage of plus the discussions the Canada Revenue Agency (CRA) is having related to active and inactive income for certain investors. For this article, let’s discuss the budget changes related to TFSA’s (Tax Free Savings Account), charitable investing in limited partnerships and the murky suggestions related to intercorporate dividends. These topics may not initially sound interesting or perhaps important, but I can assure you that many people will find these issues critical. Let’s explore!
Effective January 2015, the new annual contribution limit for TFSAs has increased to $10,000. Cumulatively, this brings the contribution limit to $41,000 per person by 2015. When TFSAs were introduced in 2009, the relatively small amounts you could invest limited planning. As time has progressed though, the cumulative limits have risen sufficiently to make a difference from a tax and real estate perspective. I’ll quickly describe two benefits that I believe are more relevant today as compared to 2009.
First, you can accumulate a considerable war chest, particularly between spouses - an $82,000 combined limit. The war chest can cover opportunities and unplanned, but ultimately expected, costs. Sooner or later, a few furnaces and/or roofs must be replaced in the same year. Sooner or later, it would be really nice to quickly come up with a deposit or two on real estate for an incredible opportunity or two (after careful analysis though). Although contributions to the TFSA are non-deductible in contrast to RRSP contributions, they do accumulate income on a tax free basis. Further, and more importantly for active investors, funds can be withdrawn from the TFSA on a tax free basis and recontributed in the following year. This is a huge gotcha as many people effectively over contribute by putting funds back in the same year unknowingly. As well, let’s not omit the possibility of ultimately showing funds available for a deposit on a property for financing purposes.
Secondly, and more interesting in many cases, is the ability to use the TFSA in more of a long-term tax savings strategy for those with considerable RRSP investments. Many people have a few hundred thousand dollars saved within RRSP’s and ultimately must remove these funds from the plan (although now thanks to the 2015 budget, in a slower fashion). In removing these funds, taxes are triggered at the individual’s marginal tax rates which in many cases have not decreased significantly from when contributions were being made. In rough numbers, an individual may need to pay approximately 50% of the RRSP withdrawals to the government in taxes, absent planning. This is certainly not to say that the RRSP wasn’t valuable, but that 50% is still 50%. Ouch. Although costs are involved, when properly done you can combine real estate investments, RRSP’s and TFSA’s to create a method to “thaw” your RRSP while paying minimal taxes. It doesn’t take a whole lot of RRSP investments to make this worth considering even when your marginal tax rate is less than 50%. Given the new annual TFSA contribution limits, such planning will become more and more fruitful for real estate investors, and for that matter others with large RRSP investments. We expect to see a considerable number of RRSP investors speaking with their tax and investment advisors over the next few months to see whether such planning is appropriate in their specific cases.
Investments by Registered Charities in Limited Partnerships
For real estate investors operating with limited partnerships, it could now be possible to have a portion of their partnership in the hands of charities. Previously this was not practical as partners would be considered to be carrying on business in common with a view to a profit, which was prohibited for charities. A couple of primary requirements exist though:
- The charity – together with all non-arm’s length entities – must hold no more than 20% of the limited partnership; and
- The charity must deal at arm’s length with each general partner of the limited partnership
Similar legislation is to be introduced for Canadian amateur athletic trusts and private foundations.
Certainly provisions are in place to protect perceived abuses where the donor and donee are too close. But, what an opportunity for charities to open up a whole new world of investment opportunities to them! Properly managed, this benefits not only the investment organizers and other investors, but the charities and foundations as well.
Changes to section 55 of the Income Tax Act
OK, what the heck is this and who cares?
As a general comment, section 55 relates to paying dividends and transferring assets between corporations. Sounds simple? However, the government has proposed substantial changes to the provisions which otherwise addressed what was considered abusive tax planning. As an overly simplified description, section 55 allows the government to cancel tax advantages associated with certain tax free dividends and convert them to capital gains.
It appears, based on the comments received from a joint committee of lawyers and accountants representing our respective professional bodies, in discussions with the Department of Finance, that the government did not intend the comprehensive changes indicated in the budget but rather were trying to address small technical problems. In fact, one section of the CRA has stopped ruling on specific issues until the Department of Finance clarifies their comments. The “fix” however affects many normal situations. I’ve been quite surprised not to see more uproar from lawyers, as the government appears to be severely punishing commonly used creditor protection plans, although certain elements continue to be apparently allowable.
While verbally told of many changes coming to clarify these changes, given the parliamentary summer break and scheduled election, it may take some time before details are known. In the interim, please be extra cautious in creditor protection plans, transferring assets between corporations and changing shareholdings amongst other things.
For the time being, even more diligent use of your tax advisor is strongly recommended. That being said, there are more and more benefits for many investors using corporations and I still recommend them in the vast majority of cases, although some plans may need to be tweaked.
However, it will be critical to get it right, plan it in advance and get it done on time!
George E. Dube, CPA, CA is a veteran real estate investor and accountant. He has spoken, written various articles, and co-authored two books on real estate accounting. Reach George at: firstname.lastname@example.org or @georgeEdube.