As the weather starts to become warmer and the first long weekend has just passed, we look forward to spending time outdoors with our families. Many families have great memories of times spent at the family cottage. Parents often want to pass the cottage on to their children so more memories can be made. However, there are a lot of issues that need to be considered. Should they transfer the cottage now or in their will? The kids may enjoy spending time at the cottage but are they willing to contribute to its ongoing upkeep? Sometimes a child has to move away to obtain employment, so it is more difficult for them to be able to enjoy the cottage. Often their spouses do not have the same attachment to the cottage. Perhaps, if they were honest, the kids may prefer to have the money that the cottage would bring if sold. We have all seen the increase in real estate values in southern Ontario and cottage country. In some cases parents may need to sell the cottage to fund their retirement. Whatever the case, parents should meet with their families to discuss these important decisions.
One of the big issues that will eventually have to be dealt with is the tax on the transfer of ownership. Many people fail to realize that when there is a transfer of real estate within the family it is a taxable transaction, even if it is done by way of gift. The Income Tax Act deems the individual(s) who dispose of the property to have received fair market value for the property. If this amount is greater than the cost of the property, then there is a capital gain and the resulting tax that comes with the gain. Only transfers between spouses can happen without tax. With this in mind, here are a few ideas that may help with the taxman.
Principal Residence Exemption
A gift or sale of the cottage will be treated as a disposition at fair market value. It may be possible to use your principal residence exemption (PRE) to shelter a gain from tax, whether during your lifetime or upon death. The PRE can only be used to fully shelter one property from tax if you own more than one at the same time. Therefore, if the PRE is used on the cottage, chances are there will be some tax to be paid on the disposal of the family home. If you are planning to gift the cottage now, using the PRE on the cottage will defer the tax until the family home is disposed. A complete analysis should entail determining the potential gain on both properties to determine which property would benefit most from the PRE. A DJB tax professional can help you with this analysis.
Maximize your Adjusted Cost Base
Keep track of all major repairs and improvements to your cottage over the years. You may be able to use these amounts to increase your adjusted cost base (ACB) of the property. A higher ACB will mean a lower capital gain, and lower taxes on the transfer of the cottage.
Transfer to Your Spouse
If your plan is to transfer or sell the cottage after your death, consider leaving the property to your surviving spouse. This can defer the tax, if any, until the date of your spouse’s death.
If you want to make a transfer during your lifetime, consider doing it today. This will move the future growth and future tax bill on that growth to your children, deferring the tax for years. You’ll still be deemed to have sold the property at fair market value today when making the transfer, but there might be less tax to pay now than later. Obviously, it you knew the future of real estate it would make this decision much easier. You can maintain control and use of the property even after a transfer using a trust or an agreement with your children.
Claim a Capital Gains Reserve
If you want to gift the cottage to your kids during your lifetime, consider structuring the transaction this way. Rather than gifting the property, sell it to the kids at fair market value and have them pay you using promissory notes. You don’t have to collect on the notes if your intention is to make this a gift. You can forgive the notes upon death without tax implications. If you structure the notes properly, the tax on the “sale” can be paid over a five-year period of time rather than all in one year, using what’s known as the capital gains reserve. If you simply make a gift, and taxes are owing, you’ll have to pay that entire tax bill in the year of the gift.
Claim Capital Losses to Offset a Gain
If you have other investments that have dropped in value, consider selling those assets to realize the capital losses. These losses can be applied to offset any taxable capital gain on the transfer of the cottage.
Buy Life Insurance to Cover the Taxes
While this idea won’t eliminate the tax bill upon death, it can provide needed cash to pay those taxes where the plan is to keep the cottage in the family and not sell it after you’re gone. You might also consider buying enough insurance to help fund all or part of the future annual maintenance costs.
Estate Administration Tax
If you plan on transferring the property to your children through your will, you can avoid the estate administration tax (formerly probate fees). This is a tax of approximately 1.5% of the gross value of all Ontario assets. To avoid the tax the parents can add one or more adult children to the deed as joint tenants, and have the added children sign a simple “bare trust” agreement acknowledging that the parents continue to be the only beneficial owners of the property. The children who are the trustees acknowledge in writing that they will honour their parents wishes during their lifetime, and will deal with title to the property in accordance with the provisions of the last surviving parent’s will on his or her death.
Article written by: Don Knechtel, CPA, CA