High cottage values equal succession challenges | Home Ownership

Remember when you (or your parents) bought the family cottage some forty or so years ago...for something like ten thousand dollars. Inflation is truly incredible. (Mind you, back then, a cup of coffee was about a quarter and now your Venti skim milk latte can set you back a five-spot plus change.) And now that little piece of heaven (your cottage, not the latte) is worth what?! “I’m in the money!” you want to sing! If the neighbours cottage - which you insist, isn’t half as nice - went for that much, this place must be worth a bloody fortune?!!! Good news: you are probably right. Either you have some significant retirement money if you plan to sell, you have an investment of value to leave your kids, or lucky you, you are on the recipient end and can count on a future enjoying the lazy summer life with your own kids, as you always hoped (but perhaps couldn’t afford). But hold off, nothing comes without a price. And while the rise of cottage values is exhilarating and indeed a sign of wealth creation, if you are going to be on the receiving end, you will have to pay for such a privilege.

Most cottage owners are now aware that there will be a tax hit when they sell the cottage or when they die. But the discomfort comes from not knowing how much and not planning for how that price will be paid.

1972 and 1982: the years that changed it all

In past generations, it was much less challenging to pass the cottage on to the kids. Until 1972, there was no tax on capital gains and before 1982, the principal residence exemption could be claimed by both spouses. This meant that a couple could actually have two principal residences eligible for tax-free gains on a sale or gift.

Now, a married or common-law couple is only allowed one principal residence exemption. Therefore, if both residences are sold, the gain on one sale or transfer may be tax-free, but the gain on the other will attract tax, if it has increased in value.

Paying the price of gaining value

Remember that 50% of the gain on a capital asset must be included in income in the year of the sale, or in the year of death if there is no surviving spouse. The taxable portion is taxed at the taxpayer’s marginal tax rate.

In Manitoba, for example, this marginal tax rate can range from zero (if no income), to 28% on taxable incomes from $10,000 to $38,000, and as high as 46.4% on taxable incomes in excess of $125,000. (These are approximations of the bracket thresholds.)

If you gift the cottage to a family member, this is still a deemed disposition for tax purposes, as the family member is not dealing with you “at arm’s length.” The same holds true if you transfer it to a trust for the benefit of your family or to a corporation that you control.

(By the way, if you are ever gifting away a property, make sure your lawyer does NOT transfer it for a dollar, or that one dollar becomes the cost base for the next sale. Make sure it is a gift and not a sale for a dollar. As long as it is a gift for zero consideration, then the person who receives it can use the fair market value at the time of gift as the cost base to calculate future gifts.)

If you instead sell to a third party for full value, the tax on the gain is covered by the proceeds of the sale. Gifts, on the other hand, do not generate cash, and therein lies the conundrum. There may still be tax to pay. And yes, you need to have that cash on hand.

Sibling rivalry extends to the cottage

The first step is to determine who in the family really wants the cottage, can afford to keep and maintain it and will play well with others, if sharing among siblings (they never do stop squabbling, do they). The family cabin can have a lot of sentimental value for family members, so this may be tough.

If you expect some siblings to want the camp property and not others, you can put a clause in your Will that allows any to use some of their other inheritance to purchase a portion of the cottage, or to decline that option. Ownership of the property may be divided into as many parts as siblings who want it. The others can take cash.

Also, think now about how the usage and upkeep responsibilities will be determined. Siblings should come to an agreement amongst themselves, with your input.

Yes, you can be creative with the taxman

On the tax side, be creative in how you use that principal residence exemption. It does not have to apply to your house in the city. On the death of the second spouse (or a sale of both properties), both residences are deemed to be sold. The executors can decide after the fact which one is treated as the principal residence. Obviously, pick the one that has gained the most in value since purchase.

When calculating the gain, include all allowable capital expenditures into the cost base - things like that new dock you installed, erosion protection, cottage additions, the new driveway from two summers ago - to minimize the net gain that must be claimed.

Think insurance

If you have been fortunate enough to have had both properties increase in value, then you should make arrangements now to have the cash available for the future tax, when that time comes. The best way to have guaranteed cash available upon death is a life insurance policy. In this case, a joint and last-to-die term-to-100 or universal life is probably the ideal type of contract, although whole life also works. Last-to-die polices are cheaper, as the rates are based on the spouse with the longer life expectancy. How this works: the death benefit is tax-free and will enhance the estate, making sure the liquid cash is there for the taxes.

‘Trust’ your family

An alternative is to take action now and transfer the cottage into the children’s name, or into the name of a corporation or trust for their benefit. However, half of any gain to the date of transfer will be taxable.

The advantage of these more complicated arrangements is that the corporation or trust does not die. The cottage can be held into future generations without a disposition of the property. However, you must plan ahead for the transfer of the shares or the trust’s interests.

Family plan

A lot to think about it, isn’t it? But you DO have to think about it (and do it now when it’s not too late). Round the family around the campfire/deck chairs/patio and get the discussion going. A woman with a plan is one who ensures the wealth – and good times – stay where they belong... in the family (cottage).

The preceding article is provided as an introduction to this topic and should not in any way be construed as a replacement for proper professional advice.

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