Do Real Estate Investors Need a Family Trust?

By: George E. Dube, CPA, CA, LPA

Family trusts are a cost-effective tool to meet multiple tax, legal and business objectives for real estate investors, and are therefore becoming a more prevalent tool for real estate investors. They are also a great way to ensure any children or dependants, (someone who depends on the investors, such as a special needs child), have access to the estate once family members pass away. This is especially important if investors have special needs dependants they need to look after. A special needs trusts attorney in New Jersey, New York, or wherever you may live, can make arrangements so that ones investors pass, dependants have access to their families investments and can continue living life as they were without too much disruption. Lets explore why family trusts merit your consideration.

What is a trust?

In simple terms, a trust is a relationship where at least one person holds title to property for the benefit of another. Typically, in family trusts we deal with, the property is either real estate or shares of a corporation which in turn owns real estate.

Investors must exercise caution in establishing a family trust as some very serious tax implications can result from improper preparation. However, when you structure a family trust appropriately, investors can realize many benefits. People also have the option of using corporate trustees instead, if they either don’t have a family member they could give the responsibility to, or if they would simply prefer a more business-like approach to the dispersion of their assets.

Flexibility of family trusts

As many of my readers know, I am a huge fan of flexibility in structuring investments. A family trust allows the trustees the ability to decide at a later period in time who will receive what amount of assets. This could include estate assets, life insurance (see more at ParadigmSettlements.com), and other financial items. Typically, this is within 21 years due to rules which deem that a trust must sell all of its assets at fair market value and thus trigger taxes. These assets can be distributed tax free to the beneficiaries. Yes – tax free. Beneficiaries may include spouses, children, grandchildren, nieces, nephews, parents, siblings or the neighbour’s dog.

Essentially this allows the trustees to decide which beneficiaries will receive which assets from the trust. This may be an equal split, or practically any other distribution, assuming that the trust agreement provides full discretion to the trustees. Practically, this can also allow trustees to observe younger beneficiaries grow up to see who may be best able to run the family business or who may deserve this opportunity through whatever criteria, if any, that are established under the trust. Some beneficiaries could receive voting control of a company, for example, while others receive income rights from the same company. Many possibilities exist for deciding who receives what and how it’s determined.

Potential benefits of a trust

• Various estate planning objectives and savings — be sure to talk to your estate planning lawyer to find out more about this.
• Income splitting and thus tax savings among family members
• Protection of assets from some creditors
• Avoiding probate fees
• Succession planning arrangements which can be adjusted in the future
• Maintaining the privacy of a familys wealth and dealings from public eyes which can otherwise be observed following someones death through court records
• Control of assets beyond the grave and beyond a period of ownership
• Providing for those who may not be able to provide fully for themselves (children, some disabled or elderly people)
• Savings vehicle

Using a trust and real estate to fund an education

My favourite example of how you can potentially use a family trust relates to funding a young childs or grandchild’s post-secondary education, apprenticeship, new business venture, etc.

The trust, or a corporation owned by a trust, can acquire a highly leveraged condo at $200,000, using bank financing and a loan from a parent (or funded from a line of credit, alternative loan, 2nd mortgage, etc.). Over time, if the property is held for say 21 years, a child could have – with some reasonable success – an inflation adjusted asset of $200,000 almost fully paid for. For most people, this represents a fully paid education, acquired almost free of charge, or at least heavily discounted, assuming the property cash flows. It is difficult to find a better scholarship or education program.

This cash, whether raised by selling the condo in the hands of the young beneficiary when they have a low level of income, or by remortgaging the condo to keep the investment, or simply choosing to live in an almost fully paid-for condo, would be received at or near the completion of post secondary studies – a most opportune time.

In most cases, this compares much more favourably than having a parent in a higher tax bracket sell the property, pay taxes at much higher rates, and then provide what is leftover after taxes to the child. If you have more than one child, or expect that they’ll be going to an expensive institution, simply add a couple more properties and you’re on your way!

Staying on the right side of the CRA

Once you have your family trust set up, how do you stay on the right side of Canada Revenue Agency?

Usually family trusts require an annual tax return, due March 31st, dependent on circumstances that you’ll need to discuss with your accountant. You must also file T3 tax slips each year that you distribute assets from the trust.

You must exercise care in creating and operating a family trust. A Canada Revenue Agency pilot project in the Kitchener-Waterloo region which focused on family trusts met with such a huge success that it was implemented across Canada. The audits focus on:

• ensuring that the trust was correctly established
• bank accounts were created and used
• bookkeeping was maintained using an appropriate methodology
• trustee resolutions formalized
• the beneficiaries truly received the assets of the trust (as compared to, for example, the parents using the funds supposedly destined for the children)
• loans were properly administered

Fortunately, while few people enjoy audits, if you take reasonable care in setting up and operating the trust, you have nothing to be concerned about, even if you fall under the CRA’s scrutiny. And you can realize many of the advantages of the trust.

Unquestionably, trusts are not for everyone. Often we like to see them after an investor has accumulated a bit of a portfolio or legal advisors have suggested their use for credit protection reasons.

But, the real question is: Is a trust appropriate for you?

George is a veteran real estate investor and Chartered Accountant whose practice with his partner Peter Cuttini, Dube & Cuttini Chartered Accountants LLP, focuses on providing the knowledge and tools clients from across the country, and around the world need, to increase and preserve the value of their businesses. George has written and contributed to articles in various national and regional publications and co-authored two books: 81 Financial and Tax Tips for the Canadian Real Estate Investor: Expert Money-Saving Advice on Accounting and Tax Planning (Campbell, Murji and Dube: Wiley 2010) and Legal, Tax & Accounting Strategies for the Canadian Real Estate Investor (Cohen and Dube: Wiley 2010). He also developed the accountant in-a-box? program for real estate investors. George and Peter are both members of the REIN Faculty. See: www.dubecuttini.com or contact: Info@dubecuttini.com or 1.877.475.3823.