By Jayson Schwarz LLM and Allan Church
The days are longer, the mercury is rising and many of us have started the Canadian summer ritual of the trekking to the family cottage – that oasis where we can leave the hustle and bustle of the city behind. Many of us without cottages are realising on our dream and making offers to purchase. Purchasing a cottage is simple but when we do so or if we own one already the tax consequences must be considered. Today’s article will focus on some of the tax issues for those who already own a cottage.
The value of many cottage properties has gone through the roof over the past decade or two, creating significant gains for many cottage owners. The boom in value has pumped up many personal balance sheets but has also created a silent partner in the property – the taxman!
A significant tax bill looms when the property is sold, gifted or there has been a death (excluding situations where there is a surviving joint owner). In some cases, the cottage may have to be sold to pay the taxes. So how can we plan now to minimize the tax bill in the future?
The family cottage, home to many happy memories, is often an emotionally charged topic. Simply leaving the cottage to the children is not always the best solution. The family should have an open discussion to determine whether all the children want the cottage and whether it can realistically be shared in a harmonious manner. In some cases disparities in access to the cottage or ability to fund the ongoing costs are sources of great rancour and conflict. Perhaps it is best to sell the cottage and leave the net proceeds to your heirs or you may need to adjust your estate to reflect the wants and needs of your families. This is where the right lawyer and accountant is critical.
If the decision is to keep the cottage in the family, several different options should be considered.
How Much Gain?
The first step in any plan should be to figure how much gain and how much tax you might have to deal with. The gain is what you can sell the cottage for (it’s fair market value) less what you paid for it and the cost of any improvements you have made over the years. Improvements are significant expenses such as the cost of additions, new docks, significant landscaping and the like. Make sure you keep the receipts for the improvements to make sure you get credit for them if the Canada Revenue Agency (“CRA”) wants to check your math.
Look Back to 1994
In 1994 the government cancelled the capital gains exemption on real property including cottages. As part of the transition, taxpayers were allowed to file an election to trigger a gain on property they owned. Check your 1994 tax return to see if you filed the election and increased the tax cost (and reduced the eventual gain) of the cottage.
The Principal Residence Exemption
Once you know the gain, a simple solution may be to use your principal residence exemption to shelter some or all of the gain. Where you have owned two or more properties at the same time (e.g. a city home and a cottage), a choice must be made as to how to allocate the exemption. Consult a a knowledgeable lawyer and accountant for help in determining how much tax you can save in this manner.
Life Insurance
Consideration should also be given to buying life insurance to fund the tax bill. Joint last to die insurance can often be purchased at a reasonable cost.
Watch for Market Downturns
In some markets cottage values fall quickly during tough economic times. Consideration might be given to giving some or all of the cottage to the children when the value is depressed due to poor market conditions. Tax will have to be paid on any gain realized on the gift (The taxman considers you to have sold the property for its market value when you give it to your kids or other family members.) You will have to weigh the potential savings from transferring the cottage at a lower value against paying the tax now as opposed to on death. Should you choose to give an interest in or the entire cottage to the children, you should have a written agreement that guarantees you use of the property and sets out who will pay for the various costs associated with the property.
Buying a cottage should be an enjoyable experience. Please find a lawyer and an accountant who understand cottage property and get good professional advice BEFORE you firm up that Offer or close the deal.
We wish to thank Allan Church is a Toronto/Mississauga tax accountant and partner in the accounting firm MNP LLP. for his assistance in writing this article.