Transferring it to the next generation
I met my wife on the May long weekend about a decade ago, on the beach of the cottage that had been my summer home since I was a child. It was the last — and most lasting — memory of about three decades for which our family had been there. Earlier that spring, we had decided it was time to move on, and one week later my parents sold our cottage to a young family.
Cottages, cabins and chalets are typically passed on from generation to generation. With summer on the horizon, here are some tax and legal issues to contemplate if you have a client who is considering selling the cottage to family members.
From one generation…
A transfer to anyone other than a spouse will trigger capital gains, including a proportionate deemed disposition if a non-spouse is added as a joint owner. Using the usual calculation, fair market value less adjusted cost base (ACB) yields the capital gain, half of which is included in the transferor’s taxable income. Keep in mind that as this is generally personal use property under tax law, one cannot claim a capital loss if the figure is negative.
The starting point for ACB will be the initial outlay to acquire the property plus any capital improvements. This may also have been bumped by up to $100,000 if steps were taken prior to March 1994 to preserve the then eliminated general capital gains exemption. As with all tax reporting, good recordkeeping is essential.
To counter this tax, often the property can qualify for the principal residence exemption. But bear in mind that the later availability of the exemption will be reduced or eliminated for overlapping years of ownership of other properties held by either spouse, so proceed with caution.
The spectre of a hefty capital gains tax bill may lead some to delay transfer until the last death of the two parents. Provided that this is a conscious plan, a sinking fund or joint last-to-die life insurance policy might be arranged to pay the tax. On the other hand, if this is the result of procrastination, it could merely guarantee the inevitable sale of the property if the estate has insufficient cash for the purpose.
While such a delay may defer capital gains-related tax, in some provinces the involvement of the estate will attract significant probate tax. An alternative that may bypass probate and still delay capital gains tax may be to add an adult child as a joint owner while the parents are living, but with the beneficial joint entitlement only passing upon the last parent’s death. This planning strategy should be discussed with a lawyer to determine its possible application.
On the receiving end, there are relatively few tax complications where the property is transferred to a single child. However, where there are multiple children and especially multiple generations involved, things can get interesting.
Joint ownership among siblings (or any non-spouses for that matter) can be messy in two ways. First, right of survivorship means that on a sibling’s death, his or her interest passes to the surviving joint owners whereas the more likely intention might have been for that interest (or at least its value) to fall to the deceased’s descendants. Second, the now deceased sibling’s estate could have a capital gains tax liability, adding insult to injury since the joint property interest will have passed to the surviving siblings.
An alternative to joint ownership would be to have siblings hold their interests as tenants-in-common so that a deceased’s interest falls into his or her estate. The drawback here is that it puts probate tax back on the table, not to mention the potential exponential increase in owners as the next generation comes on.
A more flexible alternative may be to establish a trust, of which the family members are beneficiaries. This could either be an inter vivos trust the parents establish while living or one or more testamentary trusts created out of their wills. Either way, it’s advisable to have a maintenance fund within the trust to facilitate general upkeep as well as capital expenses.
Some further factors that will influence the decision to transfer the family cottage include: if, when and to what extent land transfer tax may apply; whether anyone has creditor concerns; how matrimonial law may apply; and additional complications associated with foreign properties, particularly exposure to U.S. estate tax on properties south of the 49th parallel.
Of course, this is not exclusively a tax and legal decision; it’s also one that can have high emotional stakes. So if there is already a battle over who gets access to the cottage and when, it may be better to just put up a “for sale” sign and keep the memories intact.
Doug Carroll, JD, LLM (Tax), CFP, TEP, is vice-president, tax and estate planning, at Invesco Trimark.