Bare trust agreements: enabling parents to help their children purchase their first home!
As of June 1st 2021, mortgage borrowers have to meet a mortgage stress test rate of 5.25%, up from 4.79%, to qualify for a mortgage. Impacted homebuyers, in many cases first-time home buyers, will resort to adding a family member as a co-borrower to help qualify for a mortgage.
As a co-borrower, the family member would be added onto title and be a legal owner of the property. Some are hesitant to opt for this option, citing capital gains tax concerns for the parent and the loss of perks for the first-time home buyer. However, with an increasing number of lenders refusing to allow parents as guarantors, many first-time homebuyers will have no other option but to add a parent as a co-borrower.
That’s where bare trust agreements factor in. First time home buyers can leverage bare trust agreements to qualify for a mortgage while mitigating the tax implications for the parent. The bare trust agreement would declare the co-borrower as a trustee who’s only function is to hold legal title to property. Under the agreement, the bare trustee would have no beneficial rights and will only be able to act on the instructions of the beneficiary.
For instance, person A (first time homebuyer) and person B (parent) may be co-borrowers holding legal title to a property. With a bare trust agreement, person A will be declared the sole beneficiary of the property and person B declared to have zero interest in the land. Thus, securing the first-time homebuyer perks for person A while safeguarding person B from capital gains tax implications upon the sale of the property.
Land Transfer Tax
If you’re a first time homebuyer and are not familiar with land transfer taxes, this paragraph is for you. When an individual purchases real estate, they’re likely required to pay the province a land transfer tax. Typically, the tax is calculated based on the amount paid for the land. Other times, especially in non-arm’s length transactions, the land transfer tax is determined by the fair market value of the property. First time home buyers, however, are usually eligible for a refund of the land transfer tax, in part or in full. Among the different qualification requirements for this refund is the necessity for the purchaser to have never owned a home prior to the purchase. Having a parent function as a co-borrower, who likely already owns a home, seemingly poses a barrier to qualifying for this rebate…
A bare trust agreement can help first time home buyers secure the full land transfer tax refund despite a parent being listed on title. With a bare trust agreement between the co-borrowers, the Ministry of Finance will accept that the parent has no beneficial interest in the property and will allow the child to qualify for the first‑time homebuyers refund.
Capital Gains Tax
The capital gains tax is a tax paid on the profits derived from an investment. The tax is only paid once the investment is sold and profits are realized. Examples of investments subject to the capital gains tax include stocks and bonds held in a non tfsa account, as well as assets such as gold or real estate. Interestingly, the capital gains earned from the sale of land that consistently functioned as the owner’s principle residence are not subject to a capital gains tax. However, will a bare trustee who’s listed on title and will likely never live in the residence have to pay capital gains on the share they own? No.
Section 104 (1) of the Income Tax Act is interpreted to exclude bare trustees from paying taxes on the assets they hold in trust and shifts the duty to the trust’s beneficiary.[1] The Tax Court of Canada affirmed that where a bare trust is established, “Revenue Canada’s policy is to ignore the trusts for… tax purposes and to consider the settlor to be the sole owner of the property [for taxation purposes]”.[2]
Co-borrower’s liability and responsibility as a bare trustee
It’s important to note that a bare trust agreement does not absolve the co-borrower’s liability. If the beneficiary of the bare trust fails to make the mortgage payments, the co-borrower, operating as a bare trustee, is equally on the hook. Further, it’s important to ensure the trustee’s actions stay consistent with those of a bare trustee. The moment the trustee ceases to act solely on the beneficiaries’ instructions, the bare trust arrangement falls apart and tax consequences are likely to ensue.
If you’re a first-time homebuyer and need help from a parent to qualify for a mortgage, contact a lawyer at Kalfa Law Firm to help with your purchase!
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[1] Income Tax Act, RSC 1985, c 1 (5th Supp), ss. 104(1).
[2] De Mond Jr. v. The Queen, [1999] 4 C.T.C. 2007
-Ocean Enbar, Summer Law Student, JD Candidate
Ocean Enbar is a JD candidate and summer student at Kalfa Law Firm. Ocean assists our corporate, commercial, and tax lawyers in preparing research memoranda, conducting due diligence, drafting letters, and tending to the general corporate needs of our clients. Ocean completed his honours political science degree at Western University. He then worked as an intern on parliament hill until he transitioned to the private sector, interning for a reputable international lobbying firm.
© Kalfa Law 2021
The above provides information of a general nature only. This does not constitute legal advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.
