My son, Win, read a recent article I wrote about the family cottage. When he found out that my wife and I plan to transfer the property to the kids while we're still alive, he pestered me to tell him exactly when that will be.
"I'm not giving you a date son," I replied, "but I can tell you it will only be after you've got your driver's license, have graduated from university, are working full time earning a significant salary, are married with kids, and only if you eat your asparagus every time it's served between now and then." He's got his work cut out for him.
Still, the day will come. And when my wife and I give up ownership of the cottage, there could be tax to pay. The big question? How can we – or anyone – minimize the hit? Consider the following ideas:
Leave it to your spouse. If you plan to give up ownership of the cottage only after you're gone, consider leaving it to your spouse upon your death. This will defer the tax hit, if any, until your spouse passes away.
Use the principal residence exemption. Whether you sell or gift the cottage you'll be deemed to have sold it for fair market value. This could take place during your lifetime or upon death. Either way, it's possible to reduce or eliminate a taxable capital gain by using the principal residence exemption. Doing so could affect your ability to sell other properties on a tax free basis, such as your city home, so visit a tax pro to talk about it.
Transfer to the kids today. You can sell or gift the cottage to the kids during your lifetime; this can allow the future growth of the property to accrue to them and ultimately face tax in their hands rather than yours, likely years later than you'd otherwise pay the tax. You can retain the right to use the property while you're alive, and if you don't want to give up complete ownership today, you could put the property in joint names with the kids, either in joint tenancy, or as tenants-in-common.
Take back promissory notes on a sale. Suppose you want to make a gift of the cottage to your kids during your lifetime. You'll be deemed to have sold the property at fair market value which could trigger a tax bill at that time.
Instead, consider selling the property to your kids for fair market value but take back promissory notes as payment instead of cash. If your intention was to make it a gift you don't have to actually collect on the promissory notes, but can forgive the notes upon your death.
You can structure the notes so that the tax bill on the sale can be paid over five years (using something called the "capital gains reserve"). This is better than structuring the transfer as a gift where the taxes would be due in full in the year of the transfer. Speak to a tax pro about how to do this properly.
Hold the cottage in a non-profit corporation. This idea is best suited for families that expect to keep the cottage for three or more generations. The idea can allow your family to avoid capital gains taxes and probate fees on the death of any particular family member and provides a good governance vehicle to oversee management of the property. (See my article dated June 29, 2002 at waterstreet.ca)
Purchase life insurance to cover the taxes. Okay, so this idea won't exactly eliminate a tax bill owing on the cottage, but it can eliminate the need to sell the cottage or other assets to raise the cash to pay the tax bill upon death. It can also provide the cash that might be needed to help your heirs fund the maintenance and costs of upkeep for the cottage.
Establish a sinking fund to pay the taxes. This involves making regular deposits today, to a savings or investment account, to cover the ultimate taxes owing on death. The problem with this is that the tax bill is likely a growing number and could tie up a lot of capital for a completely unsatisfying purpose, making the psychological hurdle a big one. Further, if you're saving this money outside a registered plan, you'll face tax on the income earned each year, making growth of that fund very slow.
Tim Cestnick