The following is a section from The TaxLetter (MPL Communications)

(Click here for a PDF reprint of the February 2003 issue of The Tax Letter)

REITs and Income Trusts. Canadian REITs and income trusts which are structured as mutual fund trusts are qualified RRSP investments. While the main popularity of these trusts stems from higher apparent yields than conventional interest-bearing investments, the tax features can also be quite beneficial. Corporations pay tax on their income and then distribute profits as dividends, which are taxed again in the hands of shareholders (with the dividend tax credit available to non-RRSP investors). Income trusts and REITs, on the other hand, are designed so that income is reported and tax is paid by the investor, not the trust, so there is only a single level of tax. In most trusts, there is a significant element of tax shelter on cash distributions due to depreciation or similar deductions claimed by the trust. Effectively, the benefit of this shelter will eventually be “recaptured” when the investor sells the trust units, but usually as a capital gain.

If income trusts and REITS are held by an RRSP, these tax benefits will be lost. However, to the extent that distributions from the trust generate taxable income, there will be no current tax to the RRSP either. While the general rule is that personal ownership is preferable, the degree of shelter relative to the taxable income will vary from fund to fund, and may decrease over time, as assets in the trust become fully depreciated, leaving more ongoing tax exposure. However, flipping such a fund into an RRSP may result in significant tax exposure on the transfer, since the cost base of the fund will decrease as shelter is generated.

But maybe you can get the best of both worlds: A recent innovation is the Faircourt Income Split Trust, a fund which effectively bifurcates income trusts into high-tax components (designed for RRSPs) and low-tax units, designed for individual investment. My firm’s tax department tax-structured the fund, which invests in a diversified portfolio of real estate investment trusts, business and industrial funds, royalty trusts, and power generation funds.

David Louis
Minden Gross Grafstein & Greenstein LLP
111 Richmond St. W.
Suite 700
Toronto, On