Whether you call it a cottage, chalet, camp or cabin, it's your family's special place to relax and enjoy the great outdoors. And for many families, it's a place filled with happy memories that's been in the family for generations, and will be for generations to come.
But keeping the cottage in the family from one generation to the next isn't always as easy as it might seem. There are many issues to consider, including how the taxes will be paid.
Consider ways to reduce taxes
When you pass along your cottage, you are also passing along a potentially large tax bill, which your beneficiaries may or may not be able to afford. Depending on their financial situation, your beneficiaries may be forced to sell the family cottage simply to cover the taxes. There are two main types of tax to consider - capital gains taxes and probate taxes.
Capital gains taxes
If your cottage has been in the family for many years, its value has probably increased dramatically. The property your family bought for a few thousand dollars might be worth a few hundred thousand dollars today. Even property bought within your lifetime might have experienced this type of exponential growth.
This increase in value can result in a very large, taxable capital gain, which is triggered when you pass along the property to anyone other than your spouse, including your children. However, there are several ways you can address this tax bill, and even reduce or defer it.
Calculating capital gains tax
When you pass along your cottage to anyone other than your spouse, the government views it as having been sold at current market value - a "deemed disposition." The capital gain on this deemed disposition is taxable. The following example shows how there can be a $68,512.50 tax bill in 2011 on a cottage purchased for only $5,500 in 1981.
Deemed disposition in 2011: $310,000
Minus purchase price in 1981: $5,500
Total capital gain: $304,500
Capital gains taxable (50% of total): $152,250
Taxes payable at 45% marginal rate: $68,512.50
Gift the property ahead of time
Simply giving your cottage to your intended beneficiaries ahead of time is one way to defer future capital gains taxes. If you expect your cottage to significantly increase in value, consider giving it to your beneficiaries sooner rather than later.
Assuming property values will always rise, this will trigger a taxable capital gain from the appreciation of the property to date. The tax is payable in the year the gift is made. However, it should be a much smaller capital gain than the one that would be triggered in the future, assuming the property increases significantly in value. Any future gains will be taxed in the names of your beneficiaries, when they sell it or give it away at a much later date, and won't be included in your final tax return when your estate is settled.
Cover the tax bill with an insurance policy
The most common way for property to be passed on to the next generation is through a bequest made in your will. When your property is bequeathed to anyone other than your spouse, it triggers a taxable capital gain, which your beneficiaries may not be able to afford. However, you can cover this tax bill through a life insurance policy, which provides a sum equal to the expected tax bill when your estate is settled.
Please contact us at (604) 257-7455 for more information about cottage succession planning.
This article is supplied by Colin MacAskill, a vice-president and investment advisor with RBC Dominion Securities Inc. This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article. Insurance products are offered through RBC DS Financial Services Inc., a subsidiary of RBC Dominion Securities Inc. When providing life insurance products, Investment Advisors are acting as Insurance Representatives of RBC DS Financial Services Inc. MacAskill can be reached at 604-257-7455.
