Who Gets The Cottage?

May seem simple and I’m sure if you have a cottage, you have a succession plan. Most people today leave their cottage to their children in the form of a will split equally. Unfortunately, when your children have children of their own and begin their own family traditions, how will they agree on who gets the cottage? Another thing to think of are the tax liabilities that may be incurred from your children taking over your property. Later I will show you an example of this, an example that would result in your children in handing a $45,000 cheque to the Canada Revenue Agency (CRA).

Any assets you own at the time of the owners death may incur capital gains taxes. When we look at some cottages which have been in the family for decades, these rising prices of property could result in fairly large capital gains. With the recent real estate boom in Canada, cottages and other vacation properties have increased significantly in value. These properties are now worth substantially more than their purchase price. At death, 50% of this increased value is subject to taxation.

Are you aware of the impact this capital gains tax liability could have on your estate? A lack of proper planning could mean that your family cottage won't stay in your family. Your estate might need to sell it to pay the tax.

Let me first show you an example:

If a cottage was purchased 30 years ago for $60,000 and has now grown in value to $259,317, then the capital gains tax owing on the death of the owner or sale of the cottage today would be $45,843. In other words, if you pass away or dispose of that property tomorrow, the CRA will be knocking on your door for a cheque of about $45,000…not too nice is it.

Fortunately there are ways to lessen this tax liability and that’s what I want to show you.

First option we have is the use of the principal residence exemption which can be used to transfer or sell the cottage to family members. Without this principal residence exemption, there could be heavy fees involved in the way of taxes. The CRA states that you can have one principal residence listed per tax year. With this you can change your ‘principal residence’ to your cottage in order to get around having to pay capital gains taxes. Also, there are no stipulations on what has to be listed as your primary residence. So long as you ordinarily live there at some point in the year you can list it as your residence. However, with this option being explored, one thing to keep in mind is other property you may own and the gains that may be incurred on those properties.

Let me illustrate how you can use the exemption to your benefit.

Let’s say you have two properties you bought at the same time in 1991. You sell one of these properties tomorrow (2014), and one in 2021. If you don’t report the gain on the first property, you are assumed to have used the exemption and therefore pay no tax on the property. Then when you sell your second property, you will have 23 years of gains to pay (while you held two properties) and 7 years of tax-free growth.

The next option for covering this tax liability would be through life insurance. This can be a cost effective option to cover the tax liability by using the tax-free death benefit to cover any capital gains taxes that may occur when you pass away.

 Let me show you another illustration to see how life insurance can cover these capital gains.

Let us say we have a couple today Sally (50) and Roger (52), both non-smokers and in good health. They have a house worth $600,000 and a cottage worth $500,000. The house is listed as their primary residence and the cottage as their secondary. Let us also assume they are in at 42% tax bracket.

When they bought the cottage in 1991 it was worth $175,000 so they therefore have a gain of $325,000. With 50% of the gain being taxable at their current tax rate, we can see that they will have a tax liability upon the second death of the couple of $68,250.

This couple decides to take out a life insurance policy of $70,000 today to cover their tax liability and reinvest any dividends in their permanent policy to account for future growth of the property.

By paying $298.28 per month, Sally and Roger can cover that tax liability, and when dividends are issued within the policy, they will purchase more life insurance to ensure the death benefit keeps a reasonable pace with the growth of the property.

I have now shown you a bird’s eye view of two ways you can protect your estate for efficient transfer to your heirs. To discuss this in greater detail please contact me. I would love to show you how to protect your estate and protect your family in times of loss.

This material is for information purposes only and shouldn't be constructed as legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible. All comments related to taxation are general in nature and are based on current Canadian tax legislation for Canadian residents, which is subject to change. For individual circumstances, consult with legal or tax professionals.