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Advisors may want to save tax by having their lower-income spouse own part or all of their buildings. But they should consider what will happen if the spouses separate.

“We proceed on the basis that spouses will continue to be married,” says Alexandra Spinner, tax partner at Crowe Soberman in Toronto. “But what might work nicely for tax may become a problem from a family law point of view. So we’ll highlight both considerations and ask how they’d like to proceed.”

We asked Spinner and Neil Maisel, a partner in Crowe Soberman’s Valuations, Forensics and Litigation Group, to delve further into the issues.

Scenario 1:

Spouse is a beneficiary of a family trust that owns the building

A family trust “allows flexibility to determine who receives income in a particular year,” says Spinner. “Also, you’re not putting an asset directly into the hands of an individual, whether it’s your children or your spouse.”

As for taxes, “If the trust was written so that they did not have to allocate the income to the beneficiaries, then the trust would pay taxes on the income at the highest marginal rate.” Otherwise, the distributions would be taxed in the beneficiary’s hands, at their marginal rates. The advisor could make a prescribed-rate loan to the family trust to fund the building purchase (she’d also have to declare interest income). Then, the trust would purchase the building.

What if the advisor and her spouse split?

Maisel says the spouse’s trust interest is considered property under Ontario family law. “The spouse has an asset that has to be valued as of the date of separation.”

He notes that if the trust owns the building through a holding company, “the value of the shares will not necessarily equal the value of the building.” The company may have other assets and liabilities, and the valuator will factor in contingent disposition costs like real estate commissions and taxes. “The building may be worth $2 million, but even if there are no other assets or liabilities, the shares could be worth $1.8 million.”

Ontario has an equalization regime, which tallies each spouse’s share of eligible property, and subtracts debts to reach his or her net family property (NFP). The spouse with the higher NFP pays the spouse with the lower NFP half the difference. (The lowest possible amount for NFP is zero.) Each spouse owns the assets and debts in his or her name, so asset ownership is retained post-divorce (unless the spouse has to sell or transfer the asset to make the equalization payment or as part of the overall settlement).

In this case, the spouse’s trust interest would appear on his side of the calculation. Having the interest may or may not result in him owing an equalization payment, but the trust interest would remain his.

“Now the issue becomes, does she want him to effectively have an interest in the building she’s operating out of?” asks Maisel. “To some extent, he’ll become her landlord.”

How a marriage contract could help

A marriage contract could state that if the couple separates, the advisor’s spouse would renounce his beneficial interest in the trust on the date of separation, says Maisel. It could further state that the interest’s value would be calculated on the separation date. That means both sides could be protected if divorce proceedings drag and the value of the shares change in the interim.

Scenario 2:

Spouse owns shares in a corporation that owns the building

The tax benefits of having a spouse own shares in the advisor’s corporation include:

  • the spouse being able to use the lifetime capital gains exemption on the sale of qualified shares; and
  • being able to income split by distributing dividends to a spouse.

The advisor can loan her holding corporation money to purchase a building, but the loan’s interest rate must float at the prevailing prescribed rate, says Spinner.

What if the advisor and her spouse split?

The value of the spouse’s shares would go on his side of the ledger, possibly resulting in an equalization payment owing, and he’d retain share ownership post-divorce. Again, the advisor would have to consider whether she’d want her ex-spouse as her landlord. If not, she would have to buy out his shares at fair market value—provided he agreed to sell.

How a marriage contract could help

The contract could state that in the event of separation, the advisor’s spouse would have to sell the shares to the advisor for fair market value as of the date of separation, says Maisel.

Scenario 3:

Spouse owns the building directly

Having a spouse own the office building directly eliminates the setup costs involved with creating a corporation or trust. And, if the spouse is in a lower tax bracket, he can claim rental income at that lower rate. This arrangement can also protect the building from creditors if they happen to go after the advisor.

The advisor can loan her spouse the money to buy the building at the prescribed rate.

What if the advisor and her spouse split?

The building would go on the spouse’s side of the ledger, which could result in an equalization payment owing from the spouse to the advisor. He would retain title and would be the advisor’s landlord. If the advisor wanted to buy the building from him, she’d have to raise sufficient funds, but he could refuse to sell. Or, he could decide to sell it to someone else. He could also evict the advisor.

How a marriage contract could help

A marriage contract could say the spouse must sell the building to the advisor at fair market value as of the date of separation, suggests Maisel.

What if the advisor and the spouse live in part of the building?

That part is considered the matrimonial home, says Paul Slan, a partner at Gelman & Associates in Toronto. Regardless of ownership, “spouses are equally entitled to [live in] a matrimonial home until a settlement’s reached,” he says. So, even if the advisor owned her office building, the spouse would be able to stay in the living space while divorce proceedings dragged out. “She can lock her office, but she can’t boot him out,” says Slan.

Melissa Shin is deputy editor of Advisor Group.

Originally published in Advisor's Edge Report

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