Many Canadian families enjoy spending summers at the family cottage. These are typically vacation properties that the family uses for a few weeks or months from May to September or during other holidays before returning to their principal residence for the majority of the year. When creating an estate plan, passing on the family cottage is often a priority, but unfortunately there are a lot of tax complications that may make this more challenging than it ought to be.
How are Taxes Calculated? Whether you decide to transfer the cottage while you’re still living or as a part of your children’s inheritance, taxes are calculated more or less the same way. The fair market value (FMV) of the cottage will be calculated and the amount your family paid for the cottage will be subtracted from that amount. The remainder will be considered unrealized capital gains and income tax will be owing on this amount. For example, if you buy a cottage for $200,000 but it’s valued at $500,000 when you transfer it to your children, there will be an income tax liability for $300,000 in capital gains. ($500,000-$200,000 = $300,000) In Canada, 50% of capital gains is eligible for tax, which means paying tax on $150,000 of perceived income.
Paying the Taxes. Oftentimes, an estate won’t be able to absorb the income tax liability, but a common solution is for Canadians to take out a life insurance policy in order to cover the cost of the capital gains. For families who are willing their cottage to their children only after they’ve died, this strategy can work fairly well, but you’ll need to reevaluate the FMV of the cottage regularly to ensure the taxes will be fully covered. Cottages can gain value quickly, so it’s important to stay on top of these changes.
Trusts. A way to defer taxes until later is to place the cottage in a trust for your children and grandchildren. Here at MacMillan Estate Planning, we’ve worked with many Canadians who have purchased a cottage with the intention of having it enjoyed by their family for generations to come. When they realized that their estate wouldn’t be able to absorb the costs, they worked with us to create a trust that effectively deferred the tax burden. This way they could pass on their cottage without worrying that their children may lose the property due to an enormous tax cost.
MacMillan Estate Planning specializes in helping affluent Canadian families to find the right solution for their unique situation. Every family is different and so is every estate. That’s why we believe in creating personalized estate plans that prioritize your personal goals to achieve your legacy. Contact the estate experts at MacMillan Estate Planning today to get started with your free consultation.