Thanks for the Memories! Passing along the Family Cottage

Expert Advice and Planning Series with Cory Papineau, Senior Financial Advisor at Assiniboine Credit Union.
 

If you’re a cottage owner, some of your best memories probably include time with family and friends out at ‘the lake’. When the time is right, you want to pass along that special place to your kids, but what’s the best way to do it?

For many of us, this kind of planning isn’t as relaxing as a fishing weekend, but with a little forethought, it can still be smooth sailing. Here’s some typical scenarios that I hear about from members, with the pros and cons of each.
 
The Family Cottage
 

Giving the Cottage As a Gift

 
Giving the property as a gift seems like the most practical solution. You want your children to have the cottage and you wouldn’t dream of charging them for it.
 
Pro: Quick and easy. It’s over as fast as you can say, “pass the iced tea.”
 
Con:Giving the cottage as a gift has the same tax consequences as selling it. In fact, it may even result in double taxation!
 
Because the sale is considered to be between “non-arm’s length” parties, even if you charged less than fair market value for your property, or gave it away, you would still pay taxes as if you had received market price. This would mean a $200,000 cottage sold for $1 would still be taxed as $200,000.
 
It gets worse. When your children eventually sell, they will be taxed on an enormous capital gain. That’s because they’ll be paying on the difference between the initial $1 they paid and the market value of the property when they sell. If the value has gone up over time, that amount may be in excess of $200,000—the amount you already paid taxes on!
 
Cottage Family Memories
 

Joint Title

 
Adding your children’s names to the title makes them co-owners. When you pass away, they would then own the cottage outright.
 
Pro: Like making the cottage a gift, this seems like a practical solution that takes care of transfer of ownership before it becomes a question of inheritance. Your children get the cottage and you get to pass on a property that you love.
 
Con: In the eyes of the Canada Revenue Agency (CRA), this is the same as selling the property. You will pay taxes on the exchange when you change the title, based on fair market value.

 

Calculate Your Tax

By now I’m sure you’ve realized that regardless of how you choose to pass along your cottage, there will be tax implications. The best thing you can do is to know the facts so that you can make the best choice for you and your family. Start by calculating your taxes.
 
To calculate the taxes on the sale of a property that isn’t your primary residence, you first need to know your Adjusted Cost Base (ACB). Find this number by taking the original purchase price you paid when you bought the cottage, then adding the amount for any major additions or improvements you have done to the property. The result is the Adjusted Cost Base. (Note, regular upkeep and maintenance aren’t included.)

Example:

Original Purchase
Price
Additions and Improvements
(deck, well, roof, driveway etc.)
 Adjusted Cost Base
(ACB)
$75,000 $50,000 $125,000

If the cottage sells for $200,000, you have gained $75,000. At Manitoba’s highest tax bracket, you would be taxed at 23.2%, or approximately $17,400, on this sale. This amount will be added to your taxes in the year the sale is completed.

 

Manage Your Tax

Now that you understand the taxes involved with transferring your property, what’s the best way to limit the amount of tax you will pay? You have a few choices.
 
Option A: Spread out the payments for the property over time. If you sold the cottage to your loved ones over five years, you would only have to claim 1/5 of the capital gains each year. This could allow the gains to be taxed at a lower rate and may allow your family members time to absorb the cost of purchase.
 
Option B: Decide which property to claim as your primary residence. If your cottage rose in value faster than your home, you could choose to shelter the cottage gains for tax purposes and pay the capital gains on the sale of your home.
 
Option C: Use a Permanent Life Insurance Policy to pay the tax. Premiums paid over your lifetime end up being a fraction of the potential tax bill, and they are paid gradually rather than all at once.  Using a trust can also be an effective way to minimize taxes. Keep in mind, these types of solutions need to be personalized for each  family, so be sure to discuss it with your advisor before making a commitment.

 

Professional Advice

Every situation is different. While I’ve provided a few options on how to minimize the financial effects of a property transfer, there’s no substitute for professional advice. Discussing your goals before it’s time to sell is an important part of a solid financial plan—I’d be happy to help. Contact me at cpapineau@assiniboine.mb.ca or call 204-958-8612.
 
Source:  asteriskonline.ca