Don’t ignore your collectibles in tax planning. You could be very sorry

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In the first of this two-part series, I discussed estate planning missteps that were “softer” or philosophical issues.

Here, in Part 2, I address more practical and factual estate planning considerations, such as personal use property, simplifying your estate and updating the cost base of your investments.

Kids, don’t run off with the Rembrandt

People love collecting things, but when you pass away, potentially significant income tax and estate issues can apply to the ownership of collectibles.

Some people collect conventional items such as art, coins, glass figurines, stamps and old cars. Others collect less conventional items, such as duck decoys and Mason jars. And to recapture our youth, some of us collect comic books, baseball cards, dolls, train sets, Hot Wheels and action figures.

All these can be extremely valuable. It may shock many to know that a 1909 Honus Wagner baseball card sold for more than $6 million, and a 1952 Mickey Mantle rookie card for more than $5 million. These cardboard baseball cards can be worth more than paintings by famous artists.

So why am I talking about sports cards and art in the same breath? It is because all these collectibles are considered either listed personal property (LPP), such as art, coins and stamps, or personal use property (PUP), which is used for personal enjoyment, such as boats and furniture.

All of these items are subject to a deemed income tax disposition on death if they are not transferred to your spouse or a qualifying spousal trust in your will. The main difference between PUP and LPP is that you cannot claim a capital loss on PUP, and you can claim a capital loss on LPP against gains on other LPP.

Let’s look at an example of how LPP/PUP is taxed. Imagine you bought a 1952 Mickey Mantle card from your next-door neighbour when he was moving out in 1990 for $5,000. The $5,000 is now your adjusted cost base (ACB). Let’s assume the card is worth the $5 million noted above.

Your estate would have to report a capital gain of $4,995,000 ($5 million value at death less $5,000 ACB) on your final tax return, known as your “terminal return,” if you were the last spouse to die (the exception being if your spouse is still alive and you leave the card to them or a spousal trust).

To be clear, the capital gain is reported on your passing, even though the card was never sold. All the Canada Revenue Agency cares about is that the collectible was held at death.

For income tax purposes, the minimum ACB for LPP/PUP is calculated as the greater of a) the amount paid or b) $1,000 (subject to whether the card is an individual card or part of a set, beyond today’s discussion). Thus, using the example above, if you were lucky enough to find the Mickey Mantle card in a package of baseball cards and gum that you purchased for five cents at your local variety store in 1952, the ACB will be bumped up to $1,000 from five cents (I am ignoring the transitional capital gains rules that came into effect in 1972 for purpose of the example).

In addition to a potentially large inherent income tax liability (there may also be probate taxes owing), the distribution of those collectibles in your will can occasionally create issues among family members. As noted in Part 1 of this series, a rift can occur when a parent promises a certain collectible to a child and the will does not follow through on that promise. A rift may also occur if a piece of art was purchased in one child’s name and that artist becomes famous. The artist’s fame can result in that child potentially having a greater share of the estate than the other siblings, which can be problematic (I am considering the estate for practical purposes to be all items that belong to the parent and those purchased by the parent in a child’s name).

Therefore, when drafting your will, you and your estate lawyer should consider art or other properties held in your children’s names that may appreciate in value and distort intended equal distributions of your estate.

Finally, a parent may think that for tax and estate purposes it is better to ignore a collectible and let the kids “run off with the Rembrandt,” since no one will care or know better. This is clearly not legitimate tax and/or probate planning. It will put the executor(s) – who are often a child/children – in a precarious position with respect to legal, tax and probate liability, let alone leaving the issue of who gets the Rembrandt to be sorted out by your children.

If you are a collector, be it art, cars, or comics, you need to work with your professionals from both a tax and estate planning perspective when determining initial ownership (in your name, your child’s, or a trust) and how to equally distribute your collectibles upon your passing.

Consider simplifying your estate

A family office can be helpful in administering a complex estate, so your family can grieve without having to deal with the stresses and financial pressures of settling your estate. I would, however, suggest in some cases that it may make sense to minimize the complexity of your estate for the benefit of both the CEO and your surviving family.

Simplification of your estate can sometimes be a simple corporate rationalization/reorganization where the only costs are essentially professional fees and there are no negative income tax consequences. Alternatively, simplifying an estate could have significant income tax consequences or a forgone investment return cost, which require greater consideration.

If an original cottage was torn down or renovated, invoices related to the build/renovation are often missing, not issued or incomplete. This missing information should be dealt with on a timely basis.

An example of the former type of simplification is where you have a complex organizational structure, and you may be able to amalgamate, dissolve or consolidate without any tax consequences and reduce the number of companies you own.

An example of simplification with a tax cost, on the other hand, is where you were born in a foreign country and have kept investments or business structures in place back home. However, your children do not speak your mother tongue or understand the business culture and customs of that country. I have seen clients liquidate those investments to simplify their estates, which results in paying tax earlier than required and possibly giving up some upside on the investment.

You may also have business interests with friends or business associates. In the case of, say, a partnership, both parties often have no desire to keep the partnership going if one partner were to die and the other’s children step in. To avoid this, the partners sell the business or real estate earlier than they envisioned, and instead of re-investing together, they go their own separate ways.

Having someone to take care of your financial affairs after you pass away is a huge benefit in running a family office. However, I would still suggest you consider discussing with your professionals and family office CFO whether simplifying your estate as you age makes practical and income tax sense.

Know your ACBs

Over the years, I have been involved in a few situations where the adjusted cost base (ACB) information on investments or cottages or other properties was lacking when filing the final terminal tax return of the deceased client.

This could be because the investment was made before the client became successful and had a proper accounting team in place, or because the investment is just complex and messy. Either way, a low ACB can result in the payment of excess tax by the estate, and the family office should re-create, resolve or reconcile “messy” ACB situations long before the person passes away.

A complicated ACB can occur even with public company shares. I have seen discrepancies between SEDI and internal records because the public shares were purchased, granted as stock options, exchanged in corporate reorganizations, or earned as Restricted Stock Units, etc., and became jumbled together.

The determination of a cottage’s ACB is also often problematic. If an original cottage was torn down or renovated, invoices related to the build/renovation are often missing, not issued or incomplete. This missing information should be dealt with on a timely basis so that the contractors can issue duplicate invoices while they are still in their system. If not, the ACB is a best guess and there will be limited support upon a CRA audit.

Where cost base information is incomplete or missing, this item should be actioned before it gets pushed aside and support becomes difficult or impossible to find.

Mark Goodfield is the writer behind The Blunt Bean Counter blog and the book Let’s Get Blunt About Your Financial Affairs. He can be reached at bluntbeancounter@gmail.com. He has written, been quoted and interviewed on financial and taxation issues by The Globe and Mail, BNN and the Toronto Star, among other financial publications. Mark is currently looking for a new challenge outside the public accounting world.