It’s not what you earn but what you keep, and the best way to keep is through careful and often obsessive tax planning. Top accountant Tim Cestnick (The Globe and Mail columnist and CEO of Our Family Office Inc.) joins Adam & Matt this week to discuss all things tax planning – from how to structure your investment portfolio to exploring complications with principal residence exemptions. Learn what makes a great real estate investment, the most misunderstood tax rules, and some rules that might surprise you. Buckle up!
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Tim is cofounder and CEO of Our Family Office Inc. He is a CA, CPA and began his career at an accounting firm, eventually moving into tax. Tim realized he enjoyed broader, personal financial management and founded a firm that helps affluent families make wise financial decisions. His firm provides services from tax and estate planning, to investment management, to tax return preparation. Tim lives in Burlington and his office is located in downtown Toronto. He loves hockey and lives vicariously through his three kids.
On why he likes real estate as an investment vehicle:
Tim’s father has been involved in real estate development, and more recently has invested in multi-unit residential properties. As well, Tim has had the privilege of working with some of the most affluent families in Canada and around the world and he’s learned that in all cases, at least some of their money, if not all of it, has been made through real estate investment. Tim knew from a young age that owning real estate as more than his principal residence would interest him. He invests with family members as a source of extra income.
On what makes a good real estate investment:
There are different strategies, like buy, fix and flip or buy and hold. Tim and his family usually buy and hold for the longer-term. They look for properties with good cash-flow history and something they can add value to, such as by adding apartments or renovating what’s there and raising rents. They look to build long-term equity while generating enough cash in the meantime to cover their costs. They have mainly gone with multi-family properties and are now looking to generate more profit with the buy, fix and flip approach.
On how Tim’s accounting background shapes what he looks for in real estate:
As he’s a numbers guy, Tim likes to dig into the real estate numbers. This has served him well in the long-run and is good practice for anyone. Many people don’t do the math right (or at all), but this can come back to bite you if you’re not careful. There are tools and software out there to help. Tim is comfortable moving forward on properties once he’s done his homework.
On his Globe and Mail article, Selling Your Home Tax-Free may be More Complex Than You Think, and the principal residence exemption:
This is one of the most misunderstood parts of our tax law. The law says you can designate one property as your principal residence each year, meaning you can sell it tax-free (with some exceptions). When you own more than one property, it’s more complicated. Each year you pick one as your principal residence, with no need to live in it full-time (the law says you must “ordinarily inhabit the property”, which could mean just a few days per year).
For example, say you own a city home and a cabin. Over 15 years, they have both increased in value and you are now looking to sell the cabin. In order to shelter it from tax when you sell, you would need to designate it as your principal property for every year you own it. To do so, this means the city property would be subject to taxation on the gains in value for the years the cabin was designated as your principal residence. It’s best to see a tax professional to determine which property is best declared as the principal residence and therefore sheltered from tax.
On the rules for property flippers:
Just because you buy a home and live in it for a short period of time, or even a year, doesn’t mean the government will consider it your principal residence. The law says the property you sell must be a capital property or asset, as opposed to business inventory. Capital assets help generate rental or other income, whereas business inventory is bought and sold for a profit. It comes down to your intention with the property: if you intend to buy, fix and flip – even a year out – the government will treat the profit as business income, not capital gains. A principal residence exemption cannot be used to tax-shelter business income. What makes it harder now (since 2016) is we must report on tax returns every sale of a principal residence. The CRA will see when you bought and sold, which makes it easier to estimate or ask questions about your intentions. The increased valuations in markets like Toronto and Vancouver highlighted that many people make money in real estate by selling properties for significant gains, some of which are made outside of Canada. The government realized they weren’t getting as much tax as they should be, and so they instituted the 2016 reporting change.
On the differences between selling a vacation property as a principal residence versus selling a flipped property:
With vacation properties, as long as you buy additional properties for personal use, they’re considered a capital asset. You would usually determine which of the multiple properties should be deemed as your principal residence by checking which one has gone up the most in value per year of ownership. However, there are some exceptions: for instance, if you haven’t had the vacation property too long and you know you won’t sell the city property for 20 years, you might shelter the lower-valued vacation home, so you don’t pay tax today. This all differs from any property you buy for a short period of time that was never intended for personal use – you planned to buy and sell it. It can be a grey area and you need to justify your intentions to the CRA by building a case.
On how basement suites (rental income) impact the principal residence exemption:
It’s okay to rent out some of your principal residence, as long as the rental activity is ancillary or secondary to the use of the property as your principal residence. The government determines this, for instance, by whether you rent out more than half of the square footage. This would be a problem as it’s clear the rental is the primary use, and your living space is ancillary. You’ll be fine if you rent out less than 50% of the square footage.
Two other things can hurt you. If you claim depreciation on the property (capital cost allowance on the building), you can’t claim principal residence exemption. Also, if you make a major renovation to the property (e.g. adding a new suite), the CRA may say you can’t claim that portion of the property as principal residence.
On whether authorized and unauthorized suites affect how the CRA views the suite:
It doesn’t matter, surprisingly. If you rent out 60% of the square footage of your home and its unauthorized, the CRA won’t care that it’s unauthorized and still won’t count that portion towards your principal residence exemption.
On if Tim sees investors making consistent issues or mistakes:
For the most part, Tim’s day-to-day clients have learned how to invest well. However, one of his clients effectively ran an Airbnb operation before it became really popular. Most guests would stay for a couple of weeks, on average. Tim felt his client would make just as much money renting out to longer-term tenants instead, but for doing much less of the work (i.e. less cleaning and cooking, less often). The family was all-consumed by it, though, and it didn’t suit their lifestyle.
Another challenge is convincing people who have solely invested in real estate that they should invest in other alternatives, as well. Real estate isn’t well-diversified. Marketable securities or non-traditional investments like private equity are good options to supplement real estate. It’s fine to have properties in great shape but be aware of the market. Don’t over-renovate or over-invest in a property where the return might not be worth it (e.g. in Ontario there is rent control, so you can only get so much return).
On advice for portfolio structuring for tax efficiency to those starting out in real estate:
Decide how you want to make money in real estate. Buying and holding is probably the most common way. Do the math. Understand how capital gains work. Look at the purchase price and yearly rent if rented out fully, then divide it by two (Tim assumes half goes to operating expenses, but this varies). This number is your net operating income. Check what this is as a percentage of the purchase price—this ties into cap rates, which are pretty low today and means properties are expensive. Buying at a 6% cap rate in Toronto is cheap (most properties today sell at 3-4% cap rates).
It’s usually best to own property inside of a corporation, for liability reasons. Tim has holding companies for his properties, so he’s legally protected from being sued. From a tax perspective, it’s not a whole lot different from owning personally. Either way, the tax rate is about the same. Do this from the get-go as it can be expensive to transfer ownership from yourself to a company later on. However, to use the principal residence exemption, you must own property personally, as a corporation cannot claim this.
To find out more about Tim: