You have to admit that television is a great invention. It might not be the greatest invention of the past century, but it's high on the list. Yet, there's a catch. You need electricity to watch a television. Otherwise you'd be watching television by candlelight, and that's just inconvenient. Great ideas are like that - there are usually details you have to look after for the good idea to work properly.
Last week, I introduced the idea of using a trust to own your family cottage. It can be a great idea, but there are details to look after first. And I'll be the first to say that the idea isn't for everybody. Today, let me talk about some of the nuances and issues to think about if the idea intrigues you.
1. Transfers to the trust
When you transfer a cottage (or any asset for that matter) to a trust, you're generally deemed to have sold that property at fair market value. This could give rise to a tax hit on any accrued gain. You can deal with this taxable event in a couple of ways. First, consider using your principal residence exemption to shelter the gain from tax. Alternatively, if you have capital losses available, you might be able to fully or partly offset the capital gain on the transfer. Finally, if you transfer a cottage to a spousal, alter-ego, or joint-partner trust, you'll avoid the tax hit on the transfer (but these types of trusts may not suit your objectives for the cottage - speak to a tax pro).
2. Taxable benefits
If you place a cottage in a trust, be aware that the taxman will apply subsection 105(1) of our tax law to include in your income the value of all amounts paid by the trust out of its income for the upkeep, maintenance or property taxes related to the cottage. Now, don't panic: Including part of this taxable amount (your children's share) in the income of your children, assuming they are beneficiaries of the trust, won't likely cost anything in tax if your children have little or no other income. And this is an acceptable practice if your kids are benefiting from use of the cottage. The other option is to ensure you, and not the trust, are paying for these costs of upkeep.
3. Twenty-one year rule
A trust resident in Canada is generally subject to a rule that will cause a deemed disposition of the trust's property every 21 years. So, any accrued gains after 21 years could become taxable. This can be avoided by distributing the cottage out of the trust to the beneficiaries before the twenty-first anniversary, or by using the principal residence exemption available to the trust at that time. There may be other ways to manage the 21-year rule, but that's a discussion for another time.
4. U.S. estate taxes
If the cottage you own is located in the United States, you could be subject to U.S. estate taxes at the time of your death. Owning the U.S. property in a properly constructed trust should allow you to avoid U.S. estate tax and entitle you to the 15-per-cent U.S. tax on long-term capital gains. The trust must be carefully structured to avoid "grantor trust" status in the U.S. and should be established at the time you acquire the property in the U.S., not after the fact.
5. Land transfer taxes
Most provinces will levy a land transfer tax to be paid on the transfer of real estate. As a general rule, these taxes are payable only on the value of the consideration, or price, paid to purchase the property. If no consideration is paid (for example, when a cottage is gifted to a trust), then land transfer taxes will not normally apply - but check this with a lawyer in your province.
6. GST/HST issues
The sale of real estate in Canada is generally subject to GST or HST. The good news? If the seller has lived in the property as a residence (as in the case of a cottage), there will generally be no requirement to pay GST or HST. A transfer of a cottage to a trust, then, should sidestep the GST or HST requirement.
7. Borrowing to buy
If you hope to purchase your cottage in a trust rather than in your own name, your bank will still require you to personally guarantee any mortgage, and will generally expect you to put up more equity on the purchase. That is, your loan or mortgage-to-value ratio will have to be lower than if you personally owned the cottage.