The Family Cottage and Your Finances

by Ryan McLellan, Financial Advisor

Many families have an emotional attachment to the cottage. It is a place rich with memories of family gatherings and happy times. However, the prices of vacation properties have risen dramatically over the past several years, and without proper tax and estate planning, these memories can be tarnished. 

Selling a family cottage or transferring ownership can generate a substantial income tax bill, whether you do it while you’re alive or upon your death. When you transfer ownership of a vacation property to anyone other than your spouse, you will trigger a taxable capital gain on the increase in value since you bought the property.

Half the increase in value since 1971 is taxable. (Before 1971, capital gains taxes didn’t exist.) For example, a cottage purchased 20 years ago for $100,000 and worth $500,000 today would generate a $200,000 taxable capital gain. At a marginal tax rate of 45%, that would result in a $90,000 tax liability.

Fortunately, there are steps you can take to help offset or reduce capital gains taxes. Consider these strategies:

Buy life insurance coverage. The tax-free proceeds of a life insurance policy can be used to offset the taxes on a cottage that is part of your estate. Insurance can help preserve the value of the estate, and make more cash available for distribution to beneficiaries. 

Declare the cottage your principal residence. You can have only one principal residence for tax purposes, so consider designating the cottage if it has appreciated in value more than your house. Principal residences aren’t subject to capital gains taxation. For instance, if a couple has owned a cottage since before 1982, both spouses can claim partial principal residence exemptions. When considering which property to assign principal residence status, keep in mind that the tax consequences depend on the time you have owned the property and the number of years for which it is designated a principal residence. These rules can be complex, so it’s a good idea to consult with a tax professional.

Use your 1994 capital gains exemption. The federal government eliminated the $100,000 lifetime capital gains exemption in 1994. At that time, taxpayers could take advantage of a special provision to “crystallize” remaining unused lifetime room. If you claimed the crystallization related to your cottage, the cost base of the property for the purpose of calculating capital gains can be increased, reducing taxes.

Take into account improvements. The cost of improvements or additions to the cottage can be added to the cost base, potentially reducing the capital gain.

Transfer ownership while you’re alive. You can transfer ownership of the cottage to a trust that names your children as beneficiaries. This will trigger an immediate capital gain. But from that point on, gains will be taxable in your heirs’ hands. They won’t pay those taxes until they sell the property or transfer ownership.

There may be other ways to reduce taxes related to your vacation property. Speak to a financial advisor about what’s best for your situation.

You can reach Ryan at 613 823-3404;  ryan.mclellan@edwardjones.com; 10 Green Street Barrhaven, ON.

 

 

 

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