Estate planning and transferring the family cottage.
It’s been said before and it will be said again: “There are only two sure things in life: death and taxes.” We don’t know when we will die, but we certainly know when taxes will be due. What are the tax considerations on transfer of family cottages and how does estate planning help us prepare for this?
For many Canadian families a cottage is a treasure well worth keeping for future generations. It is also a significant source of tax revenue for our Canadian government through the collection of capital gains tax. If you are a cottage owner like myself, you’ve probably contemplated many different ways of passing this invaluable asset on to your children. Unless you use the cottage as your principal residence, each of the many ways of living it or leaving it to heirs has tax consequences. As a Financial Advisor in Toronto, near cottage country, here are some of the estate planning methods you may consider and their implications.
Let’s take it for granted that the cottage will keep rising in value and so will the capital gain on the property when it is distributed. (Capital gain is the difference between the cost of purchasing the asset and value of the asset when it is sold or inherited. Capital gains tax was introduced in Canada to compensate for the elimination of inheritance taxes.)
One strategy that you could employ is to sell or gift your property now to your heirs, thus crystallizing the value of the cottage today rather than leaving them to deal with a larger gain sometime in the future. Let’s say you paid $200,000 for your cottage and it is currently worth $300,000. The capital gain is $100,000 and tax will be payable on 50% of this, or $50,000. If you were to retain the property and pass it on 10 years from now when the cottage is worth $500,000, the capital gain will be $300,000 and tax will be payable on 50% of that, or $150,000.
A disadvantage of this strategy is that you may lose control of the property if it belongs to your child or children. You would want to have a written agreement, as part of your estate planning, in place to allow for your rights during your lifetime.
Incidentally, if you have done major renovations or rebuilding of your property, be sure that you keep receipts, cancelled cheques and so on to prove how much you spent. The cost of such work would normally increase your base cost and make the capital gain lower on distribution. (In our example above, if the owner had spent $100,000 on renovations, the base cost would increase from $200,000 to $300,000.)
Another estate planning strategy is to purchase life insurance to cover the estimated taxes due on the cottage. The proceeds of the insurance policy are used to pay the tax and probate fees, and the heirs don’t have to foot an onerous tax expense. You might even include enough life insurance for them to have some money for other expenses in the first year or two of owning the property. This is generally a good solution for younger people with no health problems as insurance can be very expensive as we age or our health deteriorates.
The Financial Post published a very good article on estate planning for the cottage tax bill which you can read at your leisure.
Assante’s Wealth Planning Group includes specialists in estate planning and retirement planning who can design comprehensive solutions to your lifestyle and estate objectives. Contact me for more information on access to this team of experts at firstname.lastname@example.org or by phone at (416) 939-2000.
It’s just good advice.