Retirement planning: Real estate vs. RRSPs to fund golden years

Using real estate vs. RRSPs to fund retirement

You’ll have to unwind the RRSP regardless, so watch the tax bill when selling a home for retirement income purposes

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Q: We have three rental properties in Vancouver (one is mortgage free) and own our own home (mortgage free) in the Fraser Valley.

We are both retirement age.

Should we use RRSP/ RRIF or sell the rental properties?

We have been told by different advisors conflicting opinions.

—Lee

A: Congratulations on your upcoming retirement, Lee. If you’ve owned those rental properties for more than a couple years, no doubt you’ve benefited nicely from Vancouver price appreciation.

I’ll tell you right off the bat that this isn’t one of those questions where there is an easy, obvious answer. What you should do is a personal decision, but I’ll try to highlight some of the considerations.

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Selling real estate is expensive. Of course, there’s the obvious real estate commission payable, which is generally 7% on the first $100,000 and 3% on the balance of the sale price in BC. Some agents charge more or less. Some agents do cash back. And companies offering discounted commissions as low as 1% have gained popularity in cities like Vancouver where prices are high. There is an additional 5% GST payable on the commission.

Beyond the real estate commission, you’ve got to contend with tax payable. There are two items that may contribute to tax payable on the sale of a rental property: capital gains and recapture.

Capital gains tax is payable on the increase in a property’s value from the original purchase price. The sale price less the purchase price is your capital gain. There are other adjustments you can claim against the capital gain, like the aforementioned real estate commission, legal fees and any renovations or capital improvements made over the years. 50% of your net capital gain is included on your tax return as a taxable capital gain. Tax payable on a capital gain could be as high as 24% in BC (48% on the taxable capital gain).

Recapture applies if you’ve claimed depreciation (capital cost allowance or CCA) on the property on your tax return during your period of ownership, Lee. Depreciation can reduce your taxable rental income and therefore your tax payable in a given year, but it comes back to haunt you on sale. All your historical depreciation on a property gets added to your income in the year of sale. Tax payable could be as high as 48% in BC.

You could have tax payable into the six figures if you’ve owned those properties for a while, Lee. This is a certainly a deterrent from selling.

That said, I suspect that your Vancouver real estate represents the vast majority of your net worth if your only other retirement funding source is your RRSPs. Even if your RRSPs are over $1 million, I suspect your four properties are worth millions.

On that basis, there is something to be said about rebalancing your “portfolio” – selling real estate – simply to reduce exposure. You’re all-in on Vancouver real estate and maybe you’re too concentrated.

I think you also need to consider if you will need to sell real estate during your retirement to fund your spending. If so, I think that’s more of a reason to consider it sooner rather than later so you can potentially stagger and prioritize sales. A retirement plan to model your retirement income, expenses, asset, liabilities and tax payable can help assess this.

If you’re going to sell real estate, I would attempt to minimize the tax payable to the extent you can. For example, consider selling in a low-income year after you have retired and after your salaries have ended. Consider selling before you start pensions or RRSP/RRIF withdrawals. That way, your other income sources are low in the year of sale.

Another option with a rental property instead of selling is refinancing. If you can borrow against the properties, Lee, you can access the equity without paying the capital gains tax to sell. Not everyone is comfortable with debt, but debt can be a good strategic use of real estate equity. And tax efficient in a case like this (tax-free, of course).

Selling a rental property may also give you cash to make an RRSP contribution in the year of sale and offset part of the capital gains tax inclusion – if you have RRSP room carried forward. It could also give you cash to fund your TFSAs.

The thing with your RRSPs is it’s not like you can choose to use real estate or RRSPs to fund retirement. You’re going to have to use your RRSP to fund part of your retirement whether you like it or not. By the year you turn 71, you have to either convert your RRSP to a Registered Retirement Income Fund (RRIF) or buy an annuity. RRIF withdrawals start by age 72 at latest and minimum withdrawals are required annually thereafter based on a percentage of your RRIF balance and your age. So one way or the other, you’re going to eventually start drawing down on your RRSPs, Lee.

If you guys are “retirement age,” I assume you are between 60 and 65. Whether you sell real estate or not, there could be an advantage to drawing down on your RRSPs before age 72. Income smoothing, whereby you have a steady retirement income instead of low income in the early years and high income in the later years, could save you tax dollars.

It could be advantageous to draw down on your RRSP before your start Canada Pension Plan (CPP) and Old Age Security (OAS), for example. These pensions can be deferred as late as 70 and have generous increases for delaying your application.

RRIF withdrawals after the age of 65 also qualify for the pension income tax credit, which is an annual opportunity to draw $2,000 each tax-free, or close to it, from your RRSPs.

So whether you sell your rental properties or not, consider some early RRSP withdrawals, Lee. And even though it’s tough to pay tax and cash in those Vancouver properties, you have to balance tax deferral with staying overinvested in what might otherwise be an inflated asset class. Inflated or not, you’ve got all your eggs in one basket.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.


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