The Companion Advisor:
Taxes & Estates|
Can your kids afford to inherit the family cottage?
Your cottage has been a source of enjoyment for you
and your family for years and one day you'd like it to belong to your
children. And, since you bought it, its value has gone higher and higher.
But, while it's nice to see your investment increase in value, can your
kids afford to inherit the family cottage?
It's an important question and not a thought that people often consider
when they "selflessly" leave property for others.
For example, assume you purchased a cottage in Muskoka in 1976 for $50,000.
In today's market, it is now valued at $500,000. You also own a home in
the city that you purchased for $150,000 in 1980, which is now worth about
If you transfer the cottage to your children now, you are deemed to have
disposed of the property at its current fair market value of $500,000,
resulting in an immediate capital gain. However, in determining the gain,
make sure you have properly calculated the cost of the property for tax
purposes. It may be higher than you think! The cost will be increased
by any capital improvements you have made to the cottage over the years.
It may also be higher as a result of electing to use up your $100,000
capital gains deduction back in 1994.
Principal residence designation
This may not be as bad as it sounds, since all or part of the gain can
be sheltered by the principal residence exemption. If you and your spouse
own two residences, a home in the city and a cottage, only one of the
properties can be designated as your family's principal residence each
year. Before 1982, each spouse could designate a separate property as
a principal residence for a particular year, provided the property was
not jointly owned.
The amount of taxable gain is based upon a formula that examines the
number of years you owned the property, and the number of years it has
been designated as your principal residence. In the above example, you
may decide to designate the cottage property as your principal residence
for the majority of years you owned it. In making this designation, you
will have to consider the relative appreciation of each property and the
expected timing of any sale or transfer.
Based on the above, if you own a cottage property and sell your home
in the city, you should not automatically assume that the gain on the
city home is free of tax. Careful consideration will have to be given
as to which property should be designated as your principal residence
for each year.
Based on your objectives, there are several different tax and estate
planning strategies you can use to avoid or minimize the tax hit when
you sell or transfer the family cottage. The key strategies are to make
optimum use of the principal residence exemption and to shift any future
growth in the value of the property to other family members. One of the
advantages of transferring the cottage to your children now is that your
tax liability is based on the cottage's current value. If you expect it
to appreciate significantly in value, a transfer now may be worth considering.
One of the disadvantages is that the capital gains tax must also be paid
now, rather than at some point in the future. The one exception is where
you choose to use your principal residence exemption to shelter the gain
You may also be reluctant to transfer the direct ownership of the cottage
to your children. You may not want to lose the legal control over the
property, as well as the legal right to use it. If this is the case, consider
using a family trust to hold the vacation property. There is still a deemed
disposition at fair market value when the property is transferred to the
trust, so all of the above principal residence issues still need to be
Transfer now versus on death?
Rather than transferring the property now, you may intend to let your
children inherit the property after the death of both you and your spouse.
In this situation, the capital gain will be based on the fair market value
of the property at that time. This will leave your children with a tax
bill that will have to be paid with cash which may be difficult without
selling the property or other assets. One possible solution is to purchase
a "joint-and-last-to-die insurance policy" equal to the amount
of capital gains tax that is likely to result. It can also be arranged
to have your children pay for the premiums on a shared basis, since they
will ultimately become the main beneficiaries.
Estate planning issues become more difficult where your intention is
to only have some, or just one of your children, inherit the family cottage.
Dealing equitably with all of your children based on unknown future values
can be a daunting task. No parent wants the family cottage to become a
future source of conflict. A family discussion to determine the best outcome
may help prevent problems further down the road.
One of the most important financial decisions facing cottage owners today
is the potential tax if the cottage is transferred to other family members.
Regardless of when this occurs, this liability will arise. Obviously,
there is no clear-cut answer regarding the best course of action to take.
In all cases, it's recommended you seek professional tax and legal counsel
to get advice tailored to your individual situation.
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, Fiscal Agents Money Management Newsletter
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