Posted By By John Natale
Special to the Financial Independence Hub
Summers in Canada are defined by the great outdoors and one of our favourite summer pastimes is to head up to the cottage (or cabin) to lounge on chairs, enjoy some cold beverages and toast marshmallows on the campfire for a relaxing time with friends and family.
For those who own a cottage, transferring its ownership to children or grandchildren can sometimes get tricky, with many owners failing to realize the potential tax bomb that awaits. Below is one strategy that may help ensure your property remains a space that will continue to generate positive, loving memories instead of a source of worries and sleepless nights for you and your family.
An in-depth look at the issues
For many individuals, it is important that the cottage stays in the family so the next generations can continue to enjoy it for years to come. The good news is that when you pass away, assets can be transferred to your spouse tax-free.
However, a transfer to your children, on the other hand, may trigger a capital gains tax that must be paid before the children (or their heirs) can enjoy the property. Canadian households can only use the principal residence exemption (PRE) to protect one property from tax on capital gains. If the PRE is used for the home, then the transfer of the cottage to the children will be taxable.
Over the years, many cottages and other vacation properties have increased significantly in value and are now worth much more that their purchase price. It is important to note that 50% of this increase in value is subject to taxation. Many people are not aware that this could trigger a significant capital gains tax liability for your estate and, if it doesn’t have enough assets to pay for it, the estate may be forced to sell the cottage to pay the tax. Ultimately, your family can risk losing the property altogether.
Selling the cottage now vs. later
By selling the cottage to your children today instead of transferring it when you pass away, you can cap your tax liability and pass the responsibility for any future capital gains to your children. Because the cottage is being transferred now – and will not be included as part of your estate – the family can also avoid the time and costs associated with the settling of an estate while avoiding potential claims against your estate from creditors or other interested parties.
While selling the cottage now may trigger a taxable capital gain, you can spread the payment, and consequently the taxable capital gains, out over five years if you take a mortgage back from your children. If you are also feeling generous, you can opt to make the mortgage interest-free and forgive any remaining balance in your will so that your children will own the cottage with no debt to pay.
Don’t try and reduce your capital gain by selling the cottage for anything less than the fair market value. The CRA will still calculate your capital gain based on the fair market value and when your kids sell the cottage, their cost base will equal the amount they paid, potentially resulting in double taxation.
Selling your cottage today can also serve as a source of income, if needed. Not only do the costs of maintaining a cottage disappear – and those can add up significantly over the years – but you can also use the mortgage payments to fund your retirement, help you pay for a dream vacation, or help you reach retirement much sooner than expected.
John Natale is the Head of Tax, Retirement & Estate Planning Services, Wealth, at Manulife Investment Management. He joined Manulife in 2001, having previously worked for a national account firm and a private law firm. He has experience with estate planning and wealth management strategies and a wide variety of general tax matters including trusts and annuities. John is a frequent speaker at industry conferences and seminars, has published articles on estate planning and income strategies, and has appeared as a guest speaker on BNN.
