If there is one major asset into which emotional value is invested, it is the family cottage. For parents and children alike, it can represent far more than mere bricks and mortar. Deciding when, how and to whom to transfer the cottage can be among the most challenging decisions parents ever face.
Planning for this succession is as much art as it is science, including in the latter respect the legal and tax rules that will be brought to bear. Ultimately though, those rules have to be applied within each family’s unique interpersonal dynamic, and that’s where the art comes in.
Tax on transfer
The harsh reality for many is that costs – particularly pending taxes on capital gains – will drive the need to make a decision, and will constrain the choice of options. And to be clear, it is the current owners at a given point in time who bear that tax liability.
Outside of spousal transfers, a change in beneficial ownership results in a taxable disposition, with tax due based on half of the increase in value from the adjusted cost base (ACB) to the fair market value (FMV). The ACB is the acquisition price plus any capital improvements. As well, hopefully parent-owners were able to increase their ACB, to the extent their properties had unrealized capital gains, by as much as the $100,000 general capital gains exemption before it was eliminated in 1994.
Some tax relief may be available by claiming the principal residence exemption (PRE), though that would limit use of the PRE on future disposition of other currently owned residential properties.
Form of transfer
As mentioned, tax applies to the disposition of a beneficial interest. In arm’s-length real estate sales, this almost always directly accompanies the passage of legal title. This may not necessarily be so in family situations, whether by conscious choice or operation of law. Here are some common options:
Direct transfer
Again, beneficial transfer to anyone other than a spouse will be a taxable disposition, even if little or no consideration is given in return. The related capital gain is still based on FMV minus ACB.
In a sense, this is the cleanest break, in that all property interest immediately passes to the transferee child(ren). Still, there remains the matter of how title is to be held by more than one child. While joint ownership (described below) is possible, it will usually be preferable to hold ownership as tenants-in-common, which keeps interests more discrete, with the respective interest falling into that person’s estate on death.
Added joint owner
A central feature of joint ownership is that on the death of one joint owner, the surviving owners continue on together by right of survivorship. (This can assist in bypassing probate tax in provinces where it applies.) If a new owner is added, a proportionate disposition is deemed for the existing owners. As a simple example, if a widowed mother adds her only son, there will be a one-half disposition.
With the Pecore decision of the Supreme Court of Canada in 2007, joint ownership transfers may not always be so black and white. While the decision did not deal directly with tax issues, it suggested the possibility for a beneficial right of survivorship to pass at the point of the parent’s death. Arguably, this judgement enables a deferral of capital gains taxes, but a lawyer should be consulted as to the law’s current state as subsequent cases have interpreted it in different ways.
Tax-deferred trust transfer
Parents could transfer the cottage into an alter ego or joint partner trust for their current benefit, with the children as contingent beneficiaries. The property is not deemed disposed until both spouses die (when the contingent beneficiaries become fully entitled), at which time capital gains would be calculated and tax due.
Transfer into a lifetime trust
If the parents are not concerned about a current disposition but wish to maintain control, they could transfer to a general inter vivos trust. As trustees, they would continue as legal owners with the children as beneficiaries.
Estate distribution directly or via a trust
If the cottage is held through to the death of both spouses, the capital gains tax liability arises at that time. The cottage could then be transferred directly to the child(ren) (whether as tenants-in-common or joint owners), or it could be managed through a testamentary trust outlined in the last deceased’s Will.
Funding and other complications
Despite the brief explanations of these options, things can get very complex very quickly. While an important starting point, capital gains tax really is just the tip of the iceberg. Consider:
- Are there creditor or matrimonial concerns anywhere?
- What if joint owners won’t pay their fair share for maintenance?
- Does a maintenance fund need to be pre-funded, especially where a trust is owner?
- Who should act as trustees, and how might their decisions be monitored?
- And practically speaking, who gets to use the cottage, and when?
These are all tough questions to raise, let alone answer. The key is to address them in a considered, timely and proactive manner that allows all the important issues to be canvassed.