The family cottage and how to keep it in the family

Whether you call it a cottage, chalet, camp or cabin, it’s your family’s special place to relax and enjoy the great outdoors. And for many families, it’s a place filled with happy memories that’s been in the family for generations, and will be for generations to come.

By Allan Morse

But keeping the cottage in the family from one generation to the next isn’t always as easy as it might seem. Especially if you plan to pass along the cottage to more than one person, there are several issues to consider – everything from how taxes will be paid to how the cottage will be shared. The key to a successful transition is to have a proper cottage succession plan, which addresses the various financial aspects, while preserving family harmony.

Consider ways to reduce taxes

Have you discussed tax minimization strategies with your tax advisor? If you privately own an incorporated Canadian business, there are many different tax-planning strategies that can benefit you and your family, such as paying dividends to a spouse and adult children.

Capital gains taxes

If your cottage has been in the family for many years, its value has probably increased dramatically. The property your family bought for a few thousand dollars might be worth a few hundred thousand dollars today. Even property bought within your lifetime might have experienced this type of exponential growth.

This increase in value can result in a very large, taxable capital gain, which is triggered when you pass along the property to anyone other than your spouse, including your children. However, there are several ways you can address this tax bill, and even reduce or defer it.

Calculating capital gains tax

When you pass along your cottage to anyone other than your spouse, the government views it as having been sold at current market value – a “deemed disposition.” The example below shows how a cottage purchased in 1975 for only $5,500 can result in a $68,512.50 tax bill 30 years later.

Gift the property ahead of time

Simply giving your cottage to your intended beneficiaries ahead of time is one way to defer future capital gains taxes. If you expect your cottage to significantly increase in value, consider giving it to your beneficiaries sooner rather than later. Assuming property values will always rise, this will trigger a taxable capital gain from the appreciation of the property to date. The tax is payable in the year the gift is made. However, it should be a much smaller capital gain than the one that would be triggered in the future, assuming the property increases significantly in value. Any future gains will be taxed in the names of your beneficiaries, when they sell it or give it away at a much later date, and won’t be included in your final tax return when your estate is settled.

Cover the tax bill with an insurance policy

The most common way for property to be passed on to the next generation is through a bequest made in your Will. When your property is bequeathed to anyone other than your spouse, it triggers a taxable capital gain, which your beneficiaries may not be able to afford. However, you can cover this tax bill through a life insurance policy, which provides a sum equal to the expected tax bill when your estate is settled. While the premiums can be quite expensive, particularly later in life, a common strategy is to have your beneficiaries pay the premiums, since they will ultimately benefit.

Plan now for peace of mind in the future.

Wisely Use your principal residence exemption

You can designate one property as your “principal residence” that is completely exempt from capital gains tax. And it doesn’t have to be the property you consider as your main residence. Even if you only stay at your cottage on a seasonal basis, you can designate it as your principle residence. You might consider doing this if you expect the capital gain on your main residence to be lower than the capital gain on your cottage. To take advantage of the principal residence exemption, many people will sell their main residence later in life and either downsize or move into their cottage. You can also shelter any capital gains prior to 1981, when all members of your family, including minor children, could claim a principal residence exemption on different properties. Due to the complexity of these tax rules, we recommend that you ask your tax advisor to evaluate the different alternatives available to you.

Minimizing probate taxes

Giving away your property during your lifetime is one way to avoid probate taxes due when your estate is settled. Because giving away property triggers a capital gain, you should complete a cost-benefit analysis to determine if this strategy makes sense. There are also land transfer taxes and legal fees to consider.

Other ways to avoid probate include:

Joint Tenancy with Right of Survivorship. With this form of ownership, you enter into an agreement with other people to own a share of a certain property. When one person passes away, their ownership passes to the remaining people, bypassing probate. Note that this strategy to reduce probate fees is not applicable in Quebec.

Family Living Trusts. A family trust created during your lifetime is another way you can pass along your cottage to your children or other beneficiaries, while avoiding probate. When creating a family trust, you can establish rules regarding the use of the cottage, and determine whether each child’s interest in the cottage passes to their own children, or to the other beneficiaries of the trust. Bear in mind that when you transfer a cottage to a family trust, you trigger a taxable capital gain at current market value. And every 21 years, there’s a “deemed disposition” that triggers any unrealized capital gains. For more information about cottage succession planning, please consult with your legal or tax advisor.

This article is supplied by Allan Morse, Vice-President and Investment Advisor with RBC Dominion Securities Inc. Member CIPF. This article is not intended as nor does it constitute tax or legal advice. Readers should consult their own lawyer, accountant or other professional advisor when planning to implement a strategy. Allan can be reached at 902-628-3777 or at allan.morse@rbc.com.

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