Real Estate: A Guaranteed Pension
By Brian Madigan LL.B.
With all the recent interest in pensions, it's time to look at the opportunity of owning some real estate as a pension replacement.
The pensions of auto workers are all at risk. Wouldn't they prefer something that is real and tangible? There's nothing more "real" than real estate.
Let's look at the situation of two lawyers. Robert and Greg went to law school together. Robert throughout his career worked for a high profile downtown tax law firm. He was one of the senior partners. Greg graduated near the bottom of the class, so the high profile position downtown was never a realistic opportunity.
Greg located in the suburbs, and after a period of time purchased a small house at the corner of an intersection which he used as his office.
Let's fast forward 25 years to retirement. Robert has nothing at all to show for his efforts. He paid his proportionate share of the high rents in a prestigious office tower. But, when he retired, this money had all gone down the drain.
Greg, on the other hand, developed a busy real estate practice acting for individuals as they bought and sold neighbourhood houses over the years. By, the time he retired, he had two assets for sale:
1) his law practice with 1,500 clients, and
2) his small house.
For our purposes, we'll just discuss the real estate. When Greg bought the property out in the suburbs, he paid $147,000. That seemed to be a reasonable price. He wanted a large lot to park cars, so he had an oversized lot. But, that was 25 years ago. Now, the city has been built up all around him. A developer wants his property to construct a small commercial plaza, and they have offered him $2,250,000 for his property. That's a great bonus, and Greg will be able to opt for retirement with financial security.
Here are some of the other benefits over the years:
1) the mortgage interest was tax deductible,
2) the mortgage payments at first were only slightly higher than rent (10%),
3) in the last 15 years, the mortgage payments were much less than rent,
4) he withdrew $100,000 to finance improvements to the office out of his equity, without tax implications,
5) he took capital cost allowance over the years on the value of the building,
6) he took capital cost allowance on the value of the improvements,
7) there is no capital cost recapture since he will demolish the building on the site as part of his agreement to sell the property to the developer.
Actually, there is one more significant benefit. Twenty years ago, Robert, a tax lawyer invited Greg to a conference he was hosting about the benefits of estate freezing and the use of family trusts. Greg took Robert's advice to heart, and implemented a strategy to avoid and/or defer all the taxes on the appreciation of the property for years to come.
It is noteworthy that Greg, his wife and their three children all may utilize their respective $750,000 exemption on the sale of the shares in a small business corporation. The total exemption for the family is 5 X $750,000 = $3,750,000, so they will still have room to shelter future investments.
In this particular scenario, Greg ends up with a fully paid up, non-taxable pension for free. Well, maybe not for free, but the only real premium was the 10% additional monthly payment he made over the first 10 years.
Now, he just has to pay Robert a fee for setting this whole thing up. But, Robert will still be there for a while; he can't afford early retirement.
Brian Madigan LL.B., Realtor is an author and commentator on real estate matters, Royal LePage Innovators Realty
905-796-8888
www.OntarioRealEstateSource.com
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