Nearly two years ago, I wrote a blog post titled “Assessing Drake’s Estate Planning Needs”. The post looked at rap sensation Drake’s assets vis-à-vis his intent for his son Adonis to be the sole beneficiary of his estate, and the various considerations that he ought to have in planning for the effective transition of his wealth to Adonis.
Yet, as any advisor in this space knows, the estate planning discussion can get a lot more complicated when focusing on the potential tax issues that may arise. This is especially the case with high net worth or ultra-high net worth clients like Drake.
In this post, fellow advisor Michael Dutra and I will zoom in on the specific tax issues that the estate trustees of Drake’s estate may have to deal with upon his death. What we can say is that while Honestly, Nevermind makes for a catchy title for a 2022 house-inspired album, it is definitely not the approach Drake should take to dealing with his impending tax bill.
Running Through Subsection 70(5) With My Woes (Deemed Disposition on Death and Taxation of Capital Gains)
The original blog post on this topic touched a bit on capital gains in the context of Drake’s collection of businesses under his “October’s Very Own” (“OVO”) branding. To the extent any of these businesses are shares in corporations that Drake directly owns, or, if such shares are owned by any holding companies the shares of whichDrake directly owns, then there likely will be capital gains taxes payable on Drake’s death.
This is because of subsection 70(5) of the Canadian Income Tax Act. Pursuant to this provision, upon an individual’s death they are deemed to have disposed of all of their property at fair market value (i.e. this is the case even if they haven’t actually disposed of such property). To the extent there have been any capital gains on the property (increases in value beyond the cost at which the individual acquired the property), then capital gains taxes will be payable. 50% of the gain is added as income to the individual’s terminal tax return and tax is payable at the individual’s tax rates (which are, of course, dependent on their other income). In the case of someone with a high or ultra-high net worth who likely has significant annual income, we can expect that their taxes on their capital gains will equal to roughly 50% of the 50% of the gain.
By way of example, the deemed disposition on death functions just like if the individual were to sell a piece of real property on their date of death and pay taxes on any resulting capital gains. Of course, when someone actually dies, no actual sales have taken place despite the fact that the deemed disposition has occurred. This can be a significant issue for individuals who have assets with a lot of accrued gains, but don’t have the liquidity required to satisfy the corresponding tax liabilities.
Oh You Fancy Huh? (Application of Capital Gains Liabilities to Drake’s Assets)
Various sources report that Drake’s net worth as of 2023 is somewhere between $250,000,000.00 and $270,000,000.00.[1][2] However, rumours suggest that due to his various business interests (like OVO) his net worth may actually be a lot higher, perhaps even close to a billion dollars.
Let’s take a conservative approach and assume Drake is worth $250,000,000.00. For tax planning purposes, it’s critical to get a sense—to the extent we can—as to what specific assets make up that figure. We can first start with Drake’s Toronto home, which from the last blog post we know is called “The Embassy”. Sources are valuing The Embassy at around $100,000,000.00.[3] With a cost base of reportedly $6,700,000.00, it’s possible that if Drake died the capital gain could be upwards of $93,300,000.00, with a corresponding tax bill of $46,650,000.00. Such a tax bill may indeed have Drake in his feelings.
Thankfully for Drake (or perhaps more so for Adonis), on Drake’s death his estate trustees can claim his principal residence exemption. Under the Income Tax Act, every taxpayer can claim an exemption from capital gains on the disposition of the property that is their “principal residence”, thereby preventing the application of capital gains taxes otherwise payable as a result of the deemed disposition of the property.
To obtain this exemption, the property must be ordinarily inhabited by the taxpayer, the taxpayer’s spouse or common-law partner, former spouse or common-law partner, or child of the taxpayer.[4] However, Canada Revenue Agency (“CRA”) generally interprets the requirement that the property be ordinarily inhabited broadly. For example, there is no requirement that the property be used as a residence more than any other residence owned by the taxpayer. Accordingly, vacation properties or other seasonal properties may qualify, although the taxpayer should be able to prove that they went there regularly (at least annually). For someone like Drake who has purchased and lived in numerous homes, this can be useful as he can use the exemption on the home that has seen the highest gain. His estate trustees can use his principal residence exemption on his terminal tax return.
That being said, only one property can be the taxpayer’s principal residence, and generally foreign-situs property is also subject to the deemed disposition on death.[5] This shouldn’t be an issue for Drake, as he has reportedly sold off all of his homes in the U.S.[6] There are rumours that he has bought real property in the U.K., but sources indicate this is just speculation.[7]
It’s otherwise difficult to estimate Drake’s net worth. As reported in the previous blog post, Drake’s “Air Drake” jet is reportedly worth $181.5 million. But presumably an asset like that will decrease in value over time/with use (as is the case with most vehicles).[8] It’s also difficult to know how Drake has financed his luxury assets like The Embassy or Air Drake; specifically, it’s difficult to know whether any mortgages, lines of credit or similar debts are involved. If Drake has incurred any such debts then they will obviously have an impact on his net worth.
Based on the analysis above, we can assume that the rest of Drake’s assets (assuming he has a team of good advisors) are, for the most part, in investments. This could be on both a business level (i.e. in OVO) or on a personal level (although Drake could potentially be using investment holding companies for his personal investments).
Let’s assume Drake does use corporations for both business and personal investments. If Drake started these corporations himself, then he’s likely acquired their shares at nominal value (usually between $1.00 to $100.00). Let’s also make a very rough estimation, taking into consideration Drake’s other assets and his potential financing arrangements, that the combined value of these assets are now worth $100,000,000.00. We know that if Drake dies there’s a deemed disposition on death of his corporate assets, and as such there will be a $100,000,000.00 gain and accordingly a $25,000,000.00 tax bill (50% of the gain taxed at a rate of $50%).
Even if these numbers aren’t 100% accurate, it is safe to say that Drake likely has an estate tax bill that’s in already in the tens of millions of dollars, and he’s only 36. If we go with the $25,000,000.00 figure, and we assume Drake leads a long and fulfilling life, then the tax bill will only become more unmanageable. As Drake’s net worth increases over the next years, that tax bill is going to increase as well. Over the next 20 years, if Drake plays it relatively safe with his investments and attains 5% growth annually, his $100,000,000.00 in investments turns into over $265,000,000.00 in investments, and correspondingly the $25,000,000 tax bill balloons to $66,250,000.00. And that will be before Drake even turns 57 years old. Alexa, play “I’m Upset” off of Drake’s 2018 album Scorpion.
As we can see, capital gains taxes upon death are a huge problem that require planning to address. While Drake’s net worth today is enough to satisfy the capital gains tax liability (even 20 years from now), it is liquidity that is the issue. Are his investments difficult to sell? Could he potentially sell OVO or would he want Adonis to take it over? Would Drake be okay with selling The Embassy after the years he put into constructing it, and after all the memories he’s made there? On Drake’s death, absent instructions to the contrary, generally these decisions would be up to his estate trustees. Going back to Drake’s song “Knife Talk”, it’s clear that Drake has a desire for Adonis to inherit everything that he’s built. So, liquidating these assets may not be what Drake wants.
There is a (in Drake’s case relatively minor) exemption called the Lifetime Capital Gains Exemption. There are various requirements for shares of a Canadian corporation to meet this threshold.[9] As of 2023, the exemption is $971,190.00.[10] Yet, even if Drake were to qualify for the LCGE, and even if he were to use a trust to allow Adonis to access the exemption during his lifetime, there is still at least over $23,000,000.00 in taxes to deal with today, or at least over $64,000,000.00 in taxes to deal with 20 years from now (based on our assumptions above). As suggested in the previous post, he could do an estate freeze, but this only defers future gains in value rather than address the capital gains tax liability today.
More Life (Insurance) (Life Insurance)
Given the tax issues outlined above, could Drake benefit from life insurance? Yes Indeed, and he should ensure that one or more of his privately-owned corporations is the policy owner.
Primarily, Drake should be focused on the Capital Dividend Account (“CDA”) credits for each of his corporations. Why? When there is a corporately-owned life insurance policy, and the life insured dies, this policy will be credited to the corporation’s CDA. So what? Whatever this credit is, assets can be taken out of the corporation up to this CDA credit on a completely tax-free basis (this is as opposed to dividends paid from the corporation to its shareholder, which may be subject to income tax).
So, if Drake were to buy, say, a $100,000,000.00 life insurance policy and live to life expectancy (it could, for example, be 75 years old), the CDA credit would be equal to the life insurance amount. Assuming he buys a whole life policy, which functions in part as a life insurance policy and in part as an investment product, that $100,000,000.00 would likely be worth a lot more at life expectancy. It could easily be worth $200,000,000.00 depending on how long Drake chooses to pay premiums. So, his corporation’s CDA credit could be for $200,000,000.00, meaning $200,000,000.00 of assets can come out of the corporation tax-free. So, if Drake dies, $200,000,000.00 gets paid tax-free to his corporation from the insurance company. That would lead to $200,000,000.00 sitting in cash in the corporation.
The estate trustees managing Drake’s estate, as shareholders of the corporation, can elect themselves as directors of the corporation and declare a capital dividend that that gets paid on the shares on a tax-free basis. The estate trustees can then use this money to satisfy all of Drake’s liabilities, and if there is money left over it can go straight to Adonis (assuming he’s the sole beneficiary of Drake’s estate and he’s alive at the relevant time). The remaining funds could also stay in the corporation, and if Adonis eventually becomes a shareholder then he can use that money for business expansion, investments, emergencies, and/or to pay himself a steady income stream for the rest of his life. With regards to the CDA credit, there would presumably be millions of retained earnings already sitting in the corporation that can now come out of the corporation tax-free through the CDA.[11] The point is that Drake’s estate trustees have options.
So, the key question: if Drake bought $100,000,000.00 of life insurance, how much would that cost him? Well based on the typical profile of a 36-year-old non-smoker[12] in good health, approximately $1,700,000.00 per year. But would this mean that he’s out of pocket for $1,700,000.00? No, as this would be a tax-exempt whole life policy. These dividend-paying policies come with an investment component, called the cash value, with the goal being that there are eventually more funds sitting in the investments than he’s even contributed. He can use this cash value whenever he wants; this is the benefit of having a whole-life policy.
Let’s break this point down for a moment. If Drake (through a corporation) invested $1,700,000.00 for 10 years (totalling $17,000,000.00) to buy a $100,000,000.00 life insurance policy, would he have more in the cash value than what he’s contributed? Most likely, yes. This would be an investment for Drake that goes on his balance sheet, and also provides him with the life insurance his estate is going to need. If he so chose, he could also contribute more than $1,700,000.00 annually. Insurance companies usually allow a policyholder to overfund their policy, which increases its cash value and shortens the time frame of payments. So, he could probably invest around $5,000,000.00 for 4 years and put the policy on what’s called an “offset”. This means all future premiums after the 5th year are paid using his own cash value in the policy. It’s like a self-funding mode, and he wouldn’t have to pay any more premiums out of pocket for the rest of his life so long as he has enough in his cash value to continue making payments (again, these are high-level examples).
To round things off, let’s say Drake doesn’t love investing in the stock market (he only loves his bed and his mama, after all) and instead has millions and millions, or perhaps even $100,000,000.00 in free cash? Why couldn’t his estate trustees just pay the tax bill in cash, and wouldn’t his tax bill be smaller anyway (as there no capital gains payable on dispositions of cash)? In response, query this: why would Drake keep all that money aside and never touch it during his lifetime just to pay a tax bill that’s only owed when he dies, when he could put a fraction of that into a life insurance policy, and still end up with the $100,000,000.00? Often, the point of life insurance attractive to customers is the prospect of putting in a smaller amount of money today to get a larger amount of money in the future (for the benefit of their beneficiaries). If Drake has enough cash to satisfy the tax bill, then he likely has more than enough cash to satisfy the premiums. Some life insurance policies allow for great flexibility in investing; Drake could even invest his policy in relatively safe assets like Guaranteed Income Certificates (“GICs”). So, if the premiums cost Drake $20,000,000.00 in total, but that $20,000,000.00 bought him a life insurance policy that was eventually worth $120,000,000.00 when he passed away, Drake just made an extra $100,000,000.00 for Adonis. That’ll buy Adonis a lot of extra basketballs.
A final potential planning opportunity would be for Drake to do an Immediate Financing Arrangement (“IFA”). Under an IFA, if Drake wanted to buy $100,000,000.00 of life insurance, but wasn’t to keen on being out of pocket $1,700,000.00 annually for premiums, he could borrow the entire $1,700,000.00 back every year from the cash value of his own policy and just pay interest on the annual premium instead. Assuming Drake borrows back the full premium ($1,700,000.00) at 7.2% prime, the interest cost would be $122,400. for the first year. This would allow Drake to get the life insurance he needs but get all his money back every year to continue investing in his business or personal investments. So, here’s how this works: every year, Drake writes a cheque for $1,700,000.00 to keep the tax-exempt whole life policy in force. These policies come with the life insurance and the cash value. He then uses his own cash value as collateral and borrows back the entire $1,700,000.00. It’s like when you put a mortgage on a home: the house is the asset and you loan against the asset. In this scenario, the cash value acts as the home and he is “mortgaging” against his own asset, the cash value. The interest can also be tax-deductible depending on what Drake does with the borrowed funds; for example, he could invest further in OVO, his next real estate project, or a variety of other income-generating business & investment opportunities and he deductions could come from expenses associated with these activities.[13]
So Drake, If You’re Reading This, It’s NOT Too Late! Be sure to Take Care of Adonis and plan for those capital gains tax liabilities.
Thanks again to Michael Dutra for all of his help in putting this post together.
[1] See, for example https://www.hotnewhiphop.com/667531-drake-net-worth which reports his net worth as $250,000,000.00 as of May 2023, and https://caknowledge.com/drake-net-worth/ which reports his net worth as $270,000,000.00 as of June 2023.
[2] Most sources are reporting Drake’s financials in USD, so for the purposes of simplicity we will assume that all dollar figures are in USD.
[3] See, for example: https://www.squareyards.com/blog/drake-house-celebhm
[4] There are additional rules that limit the application of the principal residence exemption where other family members are involved, but a description of those rules is beyond the scope of this blog post. For more information, please see my colleague Corina Weigl’s bulletin here: https://www.fasken.com/en/knowledge/2017/01/privateclientservicesestateplanning-20170112
[5] However, the impacts of taxation can be mitigated depending on if Canada has any tax treaties with the jurisdiction in which the property is located. This is a complicated legal area and cross-border advice should be sought.
[6] https://finance.yahoo.com/news/gone-good-star-rapper-drake-110000302.html
[7] https://uk.finance.yahoo.com/news/drake-rumoured-mystery-buyer-multi-093958765.html
[8] There are additional rules regarding capital gains and losses with respect to personal use property (including vehicles), but a description of those rules is beyond the scope of this blog post. However, my colleague Corina Weigl and I recently address these rules in this podcast: https://www.rbcwealthmanagement.com/en-ca/podcasts/episode-24-collectibles-unique-assets-in-estate-planning-part-two?fbclid=IwAR2mTTJvpwL8rvnVAzoXSe3nQJd5zF5ElI6jBOEAYAT-07a40VoO7pJhqyg
[9] A full analysis of these requirements is beyond the scope of this article, but please see the following page for more information: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-25400-capital-gains-deduction/definitions-capital-gains-deductions.html#QSBCS
[10] This is according to Canada Revenue Agency: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4013/t3-trust-guide.html#lppl
[11] This is because a corporation can also accrue CDA credits from selling assets and triggering capital gains in the course of its own operations.
[12] For the purposes of this blog post we will assume that Drake does not regularly smoke, although he has been known to smoke the occasional cigar, at least according to this blog post which diligently details all of Drake’s smoking habits: https://www.mobhookah.com/blogs/blogs/drake-smoking
Conducting research for this blog post has been pretty fun.
[13] There are other ways to make the interest tax-deductible, but a full explanation is beyond the scope of this blog post.
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