Your lawyer or accountant suggests using a trust to own your commercial property. You’ve heard of trusts in the context of wealthy families and estate planning, but you’re not sure if this applies to you or what it actually means.
Trusts can be powerful tools for property ownership, providing flexibility for estate planning, income splitting, and asset protection. But they’re also complex, expensive to set up and maintain, and subject to special tax rules that have become more restrictive in recent years.
Let me explain how trusts work for commercial property ownership and when they’re worth considering.
What a Trust Actually Is
A trust is a legal relationship where one person, the trustee, holds property for the benefit of others, the beneficiaries. The person who creates the trust and transfers property to it is the settlor.
In a property trust, the trustee holds legal title to the property. They’re the registered owner on title. But they hold it for beneficiaries who have the beneficial interest, meaning they get the economic benefit.
This separation of legal and beneficial ownership creates flexibility. The trustee manages and makes decisions about the property while beneficiaries receive income and eventually receive the property itself.
Trusts are created by a trust deed or declaration of trust that sets out the trustee’s powers, the beneficiaries’ rights, and the rules governing the trust.
Types of Trusts
Not all trusts are the same. Different types have different purposes and tax treatment.
A family trust is a common structure for holding commercial property. The family members are beneficiaries, and income can be distributed to them at the trustee’s discretion.
An alter ego trust or joint spousal trust can be created by individuals over 65. The settlor is the sole beneficiary during their lifetime, with the property passing to other beneficiaries after death.
A bare trust simply holds legal title while one or more beneficiaries have all the beneficial interest and control. Bare trusts are often used for convenience, not tax planning.
A testamentary trust is created by a will and comes into existence when someone dies. These can hold inherited property for beneficiaries.
The type of trust affects tax treatment, reporting requirements, and flexibility.
Why Use a Trust for Commercial Property
Trusts serve several purposes in commercial property ownership:
Estate planning and probate avoidance. Property in a trust doesn’t go through probate when the settlor dies, which can save time and fees.
Income splitting. Trustees can distribute income to multiple beneficiaries, potentially in lower tax brackets.
Asset protection. Property in a trust might be protected from creditors of the settlor or beneficiaries, though this depends on many factors.
Succession planning. Trusts can provide for gradual transfer of property to the next generation.
Privacy. Trust ownership might provide more privacy than personal ownership, depending on local registration requirements.
Control separation from ownership. The settlor might want someone else to manage property while family members benefit.
Whether these benefits justify the complexity and cost depends on your situation.
Tax Treatment of Trust Income
Trusts are separate taxpayers. A trust files its own tax return and can pay tax at trust rates, or it can flow income out to beneficiaries who pay tax personally.
Here’s where it gets complicated. Investment income, including most rental income, is taxed at top marginal rates if kept in the trust. There’s no graduated rate benefit like individuals have.
This means accumulating rental income in a trust is very tax-inefficient. The trust pays the highest tax rate on all income.
To avoid this, trustees usually distribute income to beneficiaries each year. The beneficiaries include it in their income and pay tax at their marginal rates.
If beneficiaries are in lower tax brackets than the settlor, this income splitting saves tax. But recent tax-on-split-income (TOSI) rules restrict income splitting in many situations.
The Tax-on-Split-Income Rules
TOSI rules, also called the kiddie tax, prevent income splitting in many family situations. Income subject to TOSI is taxed at top marginal rates regardless of the beneficiary’s other income.
TOSI applies to property income distributed to family members in many circumstances, especially when distributed to minor children or adult children not actively involved in the business.
There are exceptions for active family members, for property inherited from parents, and in other specific situations. But TOSI has made income splitting through trusts much less attractive than it used to be.
Work with a tax accountant who understands TOSI to determine whether your planned income distributions would be caught by these rules.
The 21-Year Deemed Disposition Rule
Trusts face a deemed disposition for tax purposes every 21 years. The trust is treated as having sold all its property at fair market value, triggering capital gains tax.
This creates a significant tax event every 21 years, which can be costly and disruptive. Trusts holding appreciated commercial property face large tax bills when the 21-year mark hits.
Some strategies exist to manage or defer this tax, like rolling property out to beneficiaries before the 21-year mark. But the rule creates complexity and limits the long-term use of trusts.
For commercial property expected to appreciate significantly, the 21-year rule is a major consideration.
New Trust Reporting Requirements
Starting in recent years, many trusts must file annual information returns with the CRA disclosing trustees, beneficiaries, settlors, and anyone with control over trustee decisions.
These reporting requirements apply to most family trusts. Non-compliance can result in significant penalties.
The requirements add administrative burden and cost to maintaining trusts. They also reduce privacy, as beneficial ownership information is now reported to the CRA.
Bare Trusts and Their Treatment
Bare trusts are treated differently for tax purposes. In a bare trust, the beneficiary is treated as owning the property directly for tax purposes.
This means income is taxed to the beneficiary, not the trust. The trust doesn’t file a separate return in most cases.
Bare trusts don’t trigger deemed dispositions every 21 years because the beneficiary is treated as the owner.
But bare trusts provide little flexibility. They’re mainly used for administrative convenience, not tax planning or estate planning.
Trusts and Mortgage Financing
From a lender’s perspective, trust ownership adds complexity. Lenders need to verify:
The trust exists and is validly created.
The trustee has authority to borrow and mortgage trust property.
Who will personally guarantee the debt, since trusts have no personal assets beyond trust property.
Many lenders require copies of the trust deed to verify these matters. Some lenders are less comfortable with trust ownership and might decline to lend.
The trustee borrows and signs the mortgage, but beneficial owners usually personally guarantee the debt. So the trust structure doesn’t eliminate personal liability to the lender.
Setting Up a Trust
Creating a trust requires legal documentation. A lawyer prepares the trust deed setting out:
Who the trustee is (can be an individual or a corporation).
Who the beneficiaries are.
The trustee’s powers over trust property.
Rules about distributing income and capital to beneficiaries.
How the trust can be amended or terminated.
Administrative provisions like trustee compensation and record-keeping.
The cost to set up a trust varies but typically ranges from $2,000 to $5,000 or more for a comprehensive family trust.
Ongoing Trust Administration
Trusts require ongoing administration that creates work and cost:
Annual trust tax returns must be filed, even if all income is distributed to beneficiaries.
The new beneficial ownership reporting must be filed annually.
Trust financial statements should be prepared.
Trustee decisions should be documented in minutes or resolutions.
Records of distributions to beneficiaries must be maintained.
Count on higher annual accounting fees for a trust compared to personal ownership, often $1,500 to $3,000 or more per year.
Trustee Responsibilities and Liability
Being a trustee is a serious responsibility. Trustees owe fiduciary duties to beneficiaries, meaning they must act in beneficiaries’ best interests.
Trustees can be personally liable if they breach their duties, mismanage trust property, or fail to comply with the trust deed.
Many settlors act as trustee of their own family trusts, which simplifies administration but means they’re taking on these legal responsibilities.
Corporate trustees, like trust companies, can be appointed for a fee. This provides professional management but adds cost.
When Trusts Make Sense
Despite the complexity and recent tax restrictions, trusts still make sense in some situations:
When you have a multi-generational family property and want to provide for gradual succession.
When you’re over 65 and want an alter ego or joint spousal trust for probate planning.
When you have specific estate planning goals that trusts help achieve, like providing for a disabled family member.
When you own multiple properties and want a clear succession plan for each.
When privacy about beneficial ownership is important for legitimate business reasons.
The key is that the benefits must justify the complexity and cost. For simple situations, simpler ownership structures usually work better.
When Trusts Don’t Make Sense
Trusts are probably not worth it when:
You’re young and haven’t accumulated significant assets. Estate planning can wait.
You own a single commercial property with straightforward ownership goals.
Your income is similar to your intended beneficiaries, so income splitting provides little benefit.
You value simplicity and want to minimize administrative complexity.
The property is appreciating rapidly and the 21-year deemed disposition will create huge tax bills.
Don’t create a trust just because someone mentioned it might save taxes. Analyze whether it actually provides meaningful benefits in your situation.
Alternatives to Trusts
Before creating a trust, consider alternatives that might achieve similar goals with less complexity:
Joint ownership with your spouse or children might achieve succession goals without trust complexity.
Corporate ownership provides liability protection and succession planning tools.
Direct gifting of property to family members might be simpler than holding in trust.
Life insurance can provide estate equalization or liquidity without property ownership structures.
Many goals that trusts achieve can also be accomplished through simpler structures, sometimes with better tax results.
Winding Up a Trust
If you have a trust that’s no longer serving its purpose, you can wind it up. The trustee distributes trust property to beneficiaries and the trust terminates.
This usually triggers deemed disposition and capital gains tax on appreciated property. You’ll pay tax on the accrued gain.
Factor in this exit cost when deciding whether to use a trust. You might be locking in a future tax event that’s expensive to unwind.
Professional Advice Is Critical
If you’re considering trust ownership for commercial property, work with both a lawyer and an accountant who specialize in trusts and tax planning.
The lawyer will draft the trust deed and ensure it achieves your legal and succession goals.
The accountant will model the tax implications, advise on income distributions, and ensure the trust structure provides actual tax benefits.
These professionals should work together. A legally sound trust that’s tax-inefficient doesn’t help you. Similarly, a tax-efficient structure that doesn’t legally accomplish your goals is pointless.
Questions to Ask Before Creating a Trust
Before proceeding with trust ownership, ask yourself:
What specific goal am I trying to achieve? Can I achieve it more simply?
Will the tax benefits after TOSI rules justify the cost and complexity?
Am I prepared for the ongoing administration and annual costs?
How long will I hold this property? Does the 21-year deemed disposition affect my plans?
Do I understand my responsibilities as trustee?
If the answers don’t clearly point to trust ownership being beneficial, consider alternatives.
Existing Trusts and Property Transfers
If you already have a family trust, you might transfer commercial property into it. This transfer is usually a deemed disposition triggering capital gains tax.
Some rollovers might be available to defer tax, but the rules are complex. Don’t transfer property to a trust without understanding the tax consequences.
Similarly, if a trust owns property and you want to take it out, this usually triggers tax. Plan these transfers carefully with professional advice.
Trusts in Estate Administration
Testamentary trusts created by wills are treated more favorably for tax purposes than inter vivos trusts created during life.
If estate planning is your goal, sometimes it’s better to use a will with testamentary trust provisions rather than a living trust.
Discuss with an estate planning lawyer whether a testamentary trust achieves your goals more effectively than a trust created now.
The Bottom Line on Trusts
Trusts are sophisticated tools that can provide real benefits for commercial property ownership in the right situations. But they’re not magic solutions, and they’re not right for everyone.
Recent tax changes have reduced the tax benefits of trusts for many people. The complexity and ongoing costs are significant. The 21-year deemed disposition creates long-term tax events.
If you have complex estate planning needs, significant assets, multiple beneficiaries with different needs, or specific succession goals, trusts might be worth exploring.
If your situation is relatively straightforward, you’re better off with simpler ownership structures that are easier to understand, cheaper to maintain, and more flexible.
At Creek Road Financial Inc., we finance commercial properties owned in trusts, personally, through corporations, and in various other structures. We understand the legal and practical implications of each.
If you’re considering trust ownership or already own property in trust, we can help you navigate the financing implications. We work with your legal and tax advisors to ensure your mortgage structure supports your overall planning.
Contact Creek Road Financial Inc. today to discuss financing for commercial property, regardless of how you choose to own it. We’re here to help you achieve your goals with the right structure and financing.