Real estate – Doug Carroll

Is a mortgage incentive taxable to a borrower financing a real estate purchase?

At issue

Real estate values have been rising at rates beyond historical norms over the last few years, especially in some major urban centres. Whether purchasers are seeking home ownership or investment opportunity, the usual need for mortgage financing is accentuated when property values rise so rapidly.

This is generally good news for financiers, but obviously the competition for borrowers can be stiff. The marketing minds at these institutions have come up with some innovative ways to attract the attention of purchasers, along with novel product features.

No doubt borrowers are appreciative of the competition that keeps interest rates in check, and for the perks they appear to be receiving. Appearance, however, is not necessarily reality, and a closer look at the tax implications of mortgage incentives will allow borrowers to better evaluate a given proposition.

Income Tax Act (ITA) sections

A few ITA sections have bearing on the discussion here, beginning with the basic rule of income in s.9, followed by some broad categories of income inclusions in s.12:

9. (1) Subject to this Part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year.

…

12. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable …

Among the forty or so categories in s.12, two paragraphs are of particular note: (c) interest, and (x) inducements and reimbursements.

2016-0681271E5 – Cash back amounts on renewed mortgages – March 21, 2017

In the situation brought before the CRA, a corporation receives cashback amounts from a bank at the time it renews mortgages relating to its rental properties. The cashbacks are subject to payback if certain events occur within 3 to 5 years. The questions posed are whether the cashback is taxable to the borrower, and whether any payback can be claimed as a deduction.

The CRA writer begins by ruling out the possibility of the cashback being an interest payment to the borrower. She then touches on the general rule under s.9(1), which may alone suffice, but rests the determination mainly on being an inducement pursuant to para.12(1)(x). The amount of the inducement would be treated as income for the tax year in which it is received.

As to any payback, if an inducement is included in income pursuant to para.12(1)(x), a related payback in a later tax year would entitle the taxpayer to claim a deduction under para.20(1)(hh) in that later time.

CRA Views 2015-0609071E5: Mortgage incentive – February 22, 2017

A credit union offered its members a bonus on deposits to a particular type of savings account, conditional on the funds being used as a down payment for a property purchase, with the mortgage being placed with the credit union. The credit union’s position is that, as there is already a flat interest rate on the account, the bonus should not be considered interest to the borrower.

As above, the CRA writer here also addresses whether the bonus may be interest, but does not come to a conclusion, and instead states that if the bonus does not meet that requirement then it may still be taxable under another ITA provision.

Both s.9(1) and s.12(1)(x) are dependent upon the taxpayer having income from “a business or property.” That is a question of fact, and “without a detailed review of the relevant facts and documentation, we are unable to provide a definitive response.”

Practice points

The upfront rate on a mortgage is usually the main cost to a borrower, but other fees or concessions could increase or decrease that. An inducement in the form of an incentive is one such amount that can reduce the effective cost.
Where an incentive is received by a borrower/taxpayer in the course of earning income from a business or property, such as a rental unit, the amount is likely a taxable amount.
Where the borrower is not trying to earn income from the property, for example a family home, it is not clear whether the amount is taxable. While this leaves such individuals uncertain, at the same time it is conceivable that such amounts could be received non-taxable if the incentive program is carefully designed.

Unintentionally extinguishing survivorship with joint accounts

At issue

Over the last few decades, joint ownership has grown in use as an estate planning and property succession tool involving adult children. The reason for distinguishing here between planning and succession is that joint ownership is a multi-faceted concept. Below the surface of the recorded title there can be much more going on, with beneficial rights frequently diverging from legal title. In particular, within families the law presumes that the addition of an adult child to title is not a beneficial transfer, though the child has the opportunity to rebut that.

One issue that may not be so well known is that joint ownership may operate differently with real estate as compared to bank or investment accounts. In the former case the real estate itself is the subject matter of the arrangement, whereas in the latter the practical focus (and value) is with the contents of the account.

While this may sound like splitting hairs, it can have some real world implications. If an otherwise beneficially entitled adult child is not careful in managing those joint arrangements, beneficial entitlement can be put at risk, possibly extinguishing survivorship rights.

Zeligs v. Janes, 2015 BCSC 7, supplemental reasons 2015 BCSC 525, upheld 2016 BCCA 280

Dorothy Burnett was 94 when her daughter Diana Janes (and husband) moved in with her. Within a year, Diana had been added as joint owner on the property, granted power of attorney by Dorothy, and made joint owner of Dorothy’s bank account.

In the following years, Diana borrowed against the property (for herself, not her mother) via line of credit and reverse mortgages. After Dorothy entered a nursing home at age 101, Diana sold the house for $2.7 million, retired the accumulated $832,643 in mortgage debt, and used the net proceeds to purchase a new home and investments for herself and her husband. On Dorothy’s death at age 103, as executor Diana paid the estate expenses and legacies to grandchildren, then split the residue between herself and her sister Barbara Zeligs, each receiving $63,783.

Barbara died a year after her mother, and her husband later commenced an action as executor of Barbara’s estate impugning many of Diana’s dealings with Dorothy’s affairs.

The trial judge found that though a resulting trust applied on the joint ownership of the home, Diana had rebutted that presumption as well as a claim of undue influence. The key evidence was a handwritten note the judge found expressed Dorothy’s true intention to add Diana as “joint owner as long as I live and full owner when I die.” He went on to discuss how joint ownership requires that there be four unities: title arising from same instrument, equality of interest, time of vesting, and right to possession. It was held that these unities remained intact despite the mortgages taken out by Diana, and even upon sale of the property since the proceeds were placed into the joint bank account.

However, “once they were withdrawn from the joint account for the sole benefit of [Diana and her husband], to the exclusion of Dorothy, the unity of possession was destroyed and the joint tenancy was severed.”

The court ordered half of the sale proceeds be paid to the credit of the estate. Furthermore, in supplemental reasons Diana was held to be in a conflict of interest when she used her authority under power of attorney to discharge the mortgages. She breached her fiduciary duty to Dorothy and was ordered to return $832,643 to the estate.

In the result, Diana’s actions destroyed her own right of survivorship that would have applied if the home had been held to Dorothy’s death, or even if the proceeds had remained in the joint account after Dorothy’s death.

Practice points

Joint ownership with an adult child can be more complicated than first apparent, with its application to bank and investment accounts being distinctive and potentially more complicated than in dealing with real estate.
Even if there is identity of legal and beneficial interests, the continuing form and process of dealings with the property must be carefully managed. Specifically, if property is encumbered, disposed or converted in a way that is inconsistent with the unity of interests among the owners, current and future rights may be lost.
Extra special care must be taken where the child/joint tenant also holds power of attorney over the parent’s property, especially after the parent has lost mental capacity.

Claims against the legal title to a cabin, cottage, camp or ranch

At issue

Summertime … and the livin’ is easy – or at least that was the hope when the family vacation property was acquired.

Whether it’s the cabin, cottage, camp or ranch, there is emotion tied up in such places. And as usage rolls through to the next generation and beyond, conflicts can arise, feelings of entitlement can grow, and ultimately property claims may be asserted.

One such type of claim is the doctrine of proprietary estoppel, which could apply to any real estate, though it seems to play out more prominently with vacation properties in the case law. Someone who has made a financial contribution and emotional commitment claims to have rights to the property, despite not being on the legal title.

Willmott v. Barber (1880), 15 Ch. D. 96

The doctrine of proprietary estoppel was recognized in British courts as early as 1866, and by 1880 a formal test had developed. Assuming a male claimant against a female titleholder for illustration, the “five probanda” would have to be proven:

he mistakenly thought he had a legal right,
he spent money on the property based on that belief,
she knew the extent of her own rights,
she knew of his mistaken belief, and
she encouraged or acquiesced to the expenditure.

The test has been applied in Canada many times in the century and a half since.

Schwark v. Cutting, 2010 ONCA 61

This Ontario case involved owners of “lakeview cottages” claiming the right to pass across and use the land of a beachfront property owner. The parties had a running dispute over 20 years or more, though the beachfront owner had for a time granted access in exchange for his own family’s use of stairs constructed by the lakeview owners to reach the beach.

For our purposes, the important development is that the Ontario court somewhat simplified the test for proprietary estoppel (as UK courts had done about 30 years back), requiring only that there be:

encouragement of the plaintiffs by the defendant owner,
detrimental reliance by the plaintiffs to the knowledge of the defendant owner, and
the defendant owner now taking unconscionable advantage of the plaintiff.

In the result, the lakeview owners’ claims failed, as they were not under any mistaken belief as to their legal rights. The beachfront owner had granted permission for a time, but there was nothing unconscionable about an owner withdrawing permission.

Clarke v. Johnson, 2014 ONCA 237

Whereas Schwark and Cutting were arm’s length parties, this most recent case involves a single property with family connections among the litigants.

1n 1971, William and Martha Johnson purchased an island on Lake Panage near Sudbury, Ontario, which was termed ‘the camp’. In 1979, title was transferred to be held as one-third tenants-in-common with William’s two siblings. After William’s death in 2009, Martha continued as sole owner of a one-third interest.

Donald Clarke was married to the Johnsons’ daughter Victoria when, beginning in 1974, he built a dwelling and later added other buildings and improvements. The couple had two children, Misty in 1976 and Westley in 1977. Donald and Victoria separated in 1991, but Donald continued to use and manage the camp.

Donald’s son Westley returned from western Canada in 2009, desiring to make use of the camp. After some confrontation, Donald prohibited Westley from the property, following which Martha prohibited Donald from the property.

Supported by the other two legal owner families, Donald successfully claimed proprietary estoppel. The court determined that he would have succeeded whether using the formalistic historical test or the simplified test in Schwark v Cutting. Donald was granted a constructive trust to “regulate use during his lifetime or until he could no longer attend at the camp.”

Practice points

Though the executor may have broad authority pursuant to provincial law, this is not absolute in nature. There remain a number of obligations under common law that an executor must bear in mind when exercising the authority, the nuances of which can be discussed with a lawyer if problems appear to be arising:

Legal title is important, but it should not be assumed to be all encompassing.
While the more formal test expressed in Willmott may not be required in Ontario, even the streamlined test presents a significant hurdle to a would-be claimant. On quick review of case law, it appears that other provinces may also be backing away from the more stringent test, as may be confirmed with one’s own legal advisor.
Legal disputes can be costly. In the appeal phase alone, $21,800 costs were assessed against the appellant, which would be in addition to her own legal bill.