Cottages are places where lifelong family memories are often made and live forever. These and other vacation properties are also capital assets that parents may one day wish to pass on or sell to their children or other family members. Unless the intended recipient of a property is a spouse or common-law partner, however, the intended beneficiaries could face unexpected tax problem.
“If your cottage has appreciated in value, there could be a significant capital gains liability that could force your heirs to sell the cottage,” cautions Christine Van Cauwenberghe, Vice-President of Tax and Estate Planning at Investors Group.
With proper planning, however, there are ways to reduce the future tax impact on your estate and your heirs.
Designating a vacation property as your principal residence for the purposes of claiming the principal residence exemption is one way to mitigate your tax bill. As long as you “ordinarily occupy” the property, Canadians can designate either a city- or vacation-home as their primary residence. “If your vacation home increases in value more than your city home on an annual basis, the exemption might be better applied to the vacation property,” says Van Cauwenberghe.
Preserving your cottage’s adjusted cost base (ACB) is another way to help minimize taxable capital gains. In order to take advantage of this provision, owners must fully account for all additions to the property’s ACB. Van Cauwenberghe notes that only out-of-pocket expenditures – as opposed to sweat equity – counts, so owners must be mindful to keep all receipts pertaining to capital improvements, whether they are for a new dock or other major renovation.
If there is one particular family member who you would like to see take over the cottage, it may be worth considering transferring title before you die, says Van Cauwenberghe. Cautioning that selling or gifting the property to a family member during your lifetime is a serious decision, especially if you still plan to use the cottage, if you choose to proceed and the family member pays the purchase price over a few years, “you could potentially spread the capital gain over a five-year period using the capital gain reserve,” she says. While this strategy offers the potential to see some of the gain taxed at lower rates it is important to get advice from a chartered accountant to ensure that the reserve is used properly.
Lastly, permanent life insurance offers a sound way to cover future capital gains and other estate debts – or to ensure an equitable amount of money will flow from an estate to your other children, should you decide to leave your vacation home to just one child. “In many families, life insurance is the only way to ensure there is sufficient liquidity in an estate to pay the capital gains taxes and potentially also ‘buy out’ other beneficiaries who might not be interested in keeping the cottage,” says Van Cauwenberghe.
Regardless of the strategy, she notes it is always advisable to discuss vacation-home tax issues with legal and financial professional advisors to ensure the choices made are aligned with other aspects of your financial and estate plan.
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Written and published by Investors Group as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an Investors Group Consultant.