Real estate remains the most secure and efficient way for the affluent to pass on wealth to next generation.
You may have heard all the buzz on generational wealth, as reports suggest that there is going to be $1 trillion in generational wealth transferring hands in the coming years.
When you’ve spent years accumulating your wealth, you want to take the same measured approach to ensuring that your financial legacy continues to grow and be as relatively valuable, even after you have passed on.
Just as you employed a strategy to grow and gather assets as your family grew, so do you need to devise a strategy to preserve and grow that wealth for the next generation. One wise approach is through generational wealth and real estate.
In fact, it is very possible that you have seen your real estate investment (i.e. your home) outperform all of your other investments over the years.
Perhaps you are a homeowner who has seen your home’s value grow exponentially over the last several years and would like to leave that nest egg to your children or grandchildren. Perhaps you are looking at purchasing more properties to add to your real estate portfolio, not just to generate income today, but as an investment to pass along to your heirs, that will grow and buck inflation.
And the goal, of course, is to maximize your return, without eroding your assets, which is why you have to look at things such as taxes and financing.
It’s wise to sit down with an estate planner, financial planner, accountant or lawyer to advise you on the best path forward if you are interested in exploring a generational wealth transfer strategy.
Real estate is a hedge against inflation
One of the basic principles of good investing is diversification, and real estate fits nicely into that mix. Did you know that real estate is widely considered a hedge against inflation? Unlike other investments like stocks and bonds which are more sensitive to variables and inflation for value, the physical asset that is real estate tends to outlast inflation and grow at a higher rate.
Even with higher interest rates, over time the value of real estate has shown to outpace inflation, meaning that as equity grows, your real estate investment has staying power- and will still be valuable to your heirs.
And with high inflation at the moment, real estate is becoming even more attractive.
How to transfer real estate wealth
When you die and your heirs take over your estate, your estate will have to pay probate taxes on any assets. In the case of real estate, taxes are paid on any capital gains generated from the fair market value when your heirs inherit the home vs. the sale price, should they sell the home down the road.
So with that in mind, what are some options for transferring your real estate to your heirs?
Option A is to transfer real estate holdings to your children (or grandchildren, or whomever you choose) in your last will and testament. It is important to note that you must legally own the property (i.e. if you are a joint tenant with someone else on the title, you can’t transfer your share of the real estate. It automatically goes to the other joint tenant(s).
The real estate would be taxed according to regular probate (i.e. capital gains).
Option B is if you would like to transfer the real estate investment to your heir while you are still alive. Commonly, a parent would add a child to the deed of the home as a joint tenant, and when the parent passes away the home would automatically transfer to them.
One benefit of this approach is that this transfer happens outside of the estate, meaning that the real estate holdings wouldn’t be subject to probate taxes, so there are definite tax savings there. However, things can get more complicated down the road, if the child/grandchild is married or common-law (or becomes so at some point), because their spouse becomes entitled to their proportional share of the property. Something to think about.
Option C is also done while a parent is still alive. In this case, the real estate is an outright gift. The parent has a letter prepared through their lawyer which states that the parent is transferring the property to the child (or other heir) without expectation of financial compensation, hence the gift.
Be aware though that in doing so, this will remove you from legal title on the property, which may or may not be viable (i.e., are you intending to still live in the home?)
There are some tax implications here. If the heir is as minor when you gift the home, and any rental income is generated, that tax will be levied against your income. If you are gifting for no financial consideration, the home is considered transferred at fair market value.
Option D is to set up a Inter-Vivos Trust for your real estate investment while you are still alive. In the trust, through their lawyer, the parent names the child (or other heir) as a beneficiary of the trust and then they would transfer the real estate holdings into the trust. The appointed trustee would distribute the real estate when the parent dies according what terms had been set in the trust.
For taxation, an Inter-Vivos Trust is deemed as an individual for tax purposes, meaning that the trust will pay income tax (often at the highest marginal tax rate) in much the same way that you do as an individual. However, the trust isn’t eligible for tax credits.
However, if certain conditions are met, the beneficiaries (the heirs) might pay the tax at their tax rate, which could be lower.
One benefit of going the trust route is that you maintain control over the assets while you are alive, unlike in the straight gifting option.
Is it time to add to your property portfolio?
Beyond your own personal residence, perhaps you are considering becoming a property investor. With the market having pulled back slightly, given the rising interest rates, housing prices have become more attractive to property investors.
And with razor-thin vacancy rates in a number of cities (especially in Toronto), there is opportunity to charge premium rents and generate income to build equity up in your property investment most quickly.
There is a known shortage in supply of rental units in Toronto in particular. What’s more is that the government of Canada has set aggressive immigration targets in the coming years, which suggests that demand will be robust for the future in the rental market, as the bulk of people will rent as they transition towards possible homeownership after they are established.
When looking at property options, pay particular attention to proximity to amenities, like public transit, schools, parks, shopping and restaurants. These amenities will not only draw tenants and give you the opportunity to charge higher rents, these amenities will ensure that the property stays in demand, which will help its asset value grow over time.
One word of advice; Don’t bank your return on your investment solely on housing prices appreciating.
Rather, keep your margins wide enough that your cash flow can keep you afloat. You don’t want to run a deficit, expecting that an eventual rise in housing prices will balance it out. It’s a little different with property investing – and different still if your intended goal is to create more real estate wealth for the purpose of passing on to your heirs.
What type of property would suit your ability to manage? A turn-key condo? Perhaps a duplex or a single family home? Make sure that you have a plan in place- not just for your estate planning, but for how you will manage the rental.
Making it happen
Depending on what your investment portfolio looks like, you might be able to pay in cash for a home to use as a rental property, or to gift outright to your heirs. But barring that, what are some good options to grow your generational real estate wealth?
You can tap into the equity in your own home to finance the purchase of an additional property (or properties). As your equity grows in that investment, you can in turn use that property to leverage another purchase, and so on.
Remember though, that a home with a mortgage is a leveraged investment. And interest rates are the variable against that leverage. Interest rates (and the cost of carrying the financing) erodes your overall return. That’s why good cash flow and lower ratio financial is generally a better idea as a property investor.
Did you know that homeowners who own multiple properties are one of the fastest growing buyer segments out there? Stats Can has reported that in Ontario, 16 per cent of homeowners own more than one property, whether for recreation or as a rental property.
It’s time to put the equity that you’ve spent so many years building to work for you-and for your family!