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 our family had been there. Earlier that spring we had decided among us that it was time to move on, and a week later my parents closed the sale to another young family.
For many though, the preferred route is to pass a cottage, cabin or chalet on to the next generation. With the view from this year’s May long weekend toward summer on the horizon, here are some tax and legal issues to contemplate as a family looks down that road.
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. Per the usual calculation, fair market value less adjusted cost base yields the capital gain, half of which is included in the transferor’s taxable income. Be aware 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, quite 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 cautiously.
The spectre of a hefty capital gains tax bill may lead some to delay transfer until the last death of the two parents. Assuming 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 possibility arises out of the Supreme Court’s Pecore decision in 2007, and should be discussed with a lawyer to determine its possible application in an actual family situation.
… to another
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 become challenging.
Joint ownership among siblings (or any non-spouses for that matter), can be messy in two major respects. First, right of survivorship means that on a sibling’s later death, his/her interest passes to the surviving joint owners, whereas the more likely intention might have been for that interest (or at least the value) to fall to the deceased’s descendants. Second, the now-deceased sibling’s estate could have a capital gains tax liability, in a sense 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, with the result that a deceased’s interest falls into his/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 presently, or one or more testamentary trusts created out of their Wills. Either way, it would be 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 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 US estate tax on properties south of the 49th parallel.
Of course, this is not exclusively a tax and legal decision, but rather one that can have high emotional stakes. So if there is already a battle over who gets access when, it may be better to just erect the ‘for sale’ sign and keep the memories intact.
Joint ownership is a common ownership arrangement that assures that a property remains within an ownership group, like a family — but what are the drawbacks when a cottage is owned this way?