Last time in this space, we talked about some of the delicate issues people face when deciding on how to pass on the family cottage.
Clearly, the plan you put in place must be fair, anticipating family changes through births, deaths, marriage or divorce, as well as practical issues like fixing the roof.
It also has to minimize the punishing effects of capital gains taxes. That's right. Your cottage is likely a ticking tax bomb.
If you were lucky or smart enough to buy even a modest property 30 years ago, it could, depending on the location, easily be worth 10 times what you paid for it now. This huge appreciation over the years is taxable when the property changes hands.
Even if you give it to the kids during your lifetime, your generosity will be considered a "deemed disposition" at market value — even though there's no actual sale - triggering taxes on the full amount.
This may not be as bad as it sounds for some people, since all or part of the gain can be sheltered by the principal residence exemption.
Years ago, it was possible for each family member, including children, to designate an eligible property as a principal residence. Today, it's one exemption per family. But if you bought your cottage prior to 1982, you may still be able to claim more than one property as principal residence.
To mitigate some tax, you might sell the cottage to your children over a period of five years. This enables you to recognize the total gain in smaller increments, approximately 20 per cent per year, potentially reducing the overall tax payable.
This whole area of succession planning is tricky though, so be sure to consult with a tax specialist to consider additional strategies for deferring the capital gains.
First off, you have to figure out what you might owe by establishing your real cost. Assuming the top marginal tax rate, which will vary by province, capital gains tax equals approximately 25 per cent on the difference between what you paid for the property and what it's worth today.
Cottage owners often neglect to subtract the costs of all the upgrades they made to the property, such as sunrooms, decks, extensions and other renovations. If you've kept a record of these expenses and can substantiate them, however, they can be deducted from the potential capital gain.
Generally, particularly if you're dealing with more than one heir, it's wise to use your will as the guiding instrument. In this instance, the estate will be liable for the capital gains tax.
If you leave the cottage to someone other than a spouse, several provinces also impose a probate tax of up to 1.5 per cent based on the market value of the cottage.
To protect the estate's value, you could purchase an insurance policy on your life that would pay a tax-free benefit that might cover most, if not all, the potential taxes.
You can purchase coverage on the single owner of the cottage or, as is often the case, a "joint last to die" policy on the two co-owners. Where two people are insured, the cost will usually be less than either could buy individually.
In some instances, the children purchase the policy, dividing the cost of the premiums among those who will be sharing the cottage after you pass on. Because the death benefit bypasses the estate, probate taxes don't come into play.
If you see yourself still using the property in the coming years, you might want to consider a living trust as an alternative.
By placing the cottage into a trust while you're alive, you'll still be deemed to have disposed of it at fair market value, paying the tax immediately. In other words, it's not yours anymore.
For tax purposes, it's as if the kids become owners at today's prices with you passing on any future increase in value, as well as the related tax liability, to future generations.
Everything from maintenance responsibilities to if and how the cottage might be sold can end up in the trust agreement and be subsequently carried out by the trustees you appoint.
This way, you can stipulate who has the cottage at what point in the year, or create a first right of refusal option in case of any disputes over the sale of the cottage down the road.
One final option: If you're 65 or older, consider an "alter ego" arrangement which allows you to transfer the property into a special trust and still maintain control of it, without triggering capital gains tax.
Again, all of these strategies require experienced professional guidance and some candid family discussions.
