With the warmer weather now upon us throughout much of Canada, our clients are becoming harder to track down as they extend their weekends and take advantage of time away at their cottage, cabin or vacation home.
Yet, the summer home can be fraught with emotional, tax and legal issues surrounding the ownership, use and ultimate transfer of the property to future generations.
Perhaps the biggest tax problem with vacation properties is the potential for large capital gains taxes if the property is sold, gifted to family members, or held upon the owner’s death. Poor planning could cost a lot of money and, in some cases, force the sale of a cottage that’s been in the family for generations.
Here are several easy and straightforward potential solutions and strategies for you to discuss with your clients this cottage season:
1. Improvements and renovations. It’s important to keep receipts for any improvements or renovations made to the property, as these expenditures can be added to the property’s adjusted cost base, thereby reducing the amount of capital gains tax payable upon sale, gift or death.
2. The principal residence exemption (PRE) can shelter the gain on a principal residence from capital gains taxes. Although a couple can only designate one property as their principal residence during any given calendar year, the property does not have to be located in Canada to qualify — as long as the individual who claims the PRE is a resident of Canada. Even if your client occasionally rents the property, a cottage can still qualify as a principal residence.
3. Trusts are commonly used to hold or purchase a vacation property because they prevent the “deemed disposition” of a property upon death, potentially deferring capital gains taxes until the trust’s beneficiaries — generally the children — sell or gift the property. It should be noted that transferring a property into a trust triggers immediate capital gains taxes if applicable.
4. PRE and trusts. The beneficiary of a family trust who receives a vacation property from the trust is deemed to have owned that property from the date the trust acquired it. This allows the beneficiary to use the PRE to shelter the gain from the date of original purchase or transfer into the trust — assuming the beneficiary didn’t own another principal residence during the same period.
5. Gifting. Parents may wish to give a vacation property to adult children while the parents are still alive. Although the parents will need to pay up now for the capital gains taxes accrued to date, future capital gains will accrue to the children, who may be able to use their own PRE to avoid taxation.
6. Life insurance. Finally, the purchase of a permanent life insurance policy to offset a property’s tax liability upon death can often be the cheapest and simplest solution. Even in provinces with relatively low tax rates, the cost of insurance often compares favourably to the cost of paying the capital gains taxes upon disposition —even if that’s many years away.
To read more on this topic, please see my recently updated report, What’s up dock: Tax & estate planning for your vacation property.