Monday, August 22, 2011

Thinking about handing over the cottage? It could be less ‘taxing’ these days

Your vacation property has always been a prime place for family fun and enjoyment. And you want it to continue to be your family’s happy gathering place for many years to come – even after you are gone. If you’re considering ways to make the transfer to your children, an economic downturn could actually be to your advantage – your tax advantage, that is.

When you die, your assets can usually be passed to your spouse or common-law partner without incurring a tax liability. But if you leave capital assets – such as your cottage – to anyone else, including your kids, you’re deemed to have disposed of those capital assets at fair market value. If your cottage property has appreciated in value, your estate could be hit with a significant capital gains liability.

If you leave your cottage to your children in your will, you have no way of knowing how much of a tax hit they’ll take – maybe a big enough hit that they won’t be able to afford to continue owning the cottage.

While real estate values are ebbing, it may not be an entirely bad thing. Real estate prices may rebound in the future – historically, that has been the case. Instead of leaving the property as a bequest in your will, you can transfer cottage ownership to your kids now, either as an outright gift or by selling it to them. The transfer will trigger an immediate capital gain but the property will be valued at the current reduced market level, which could save a significant amount of tax.

If you are going to sell the property to your children, be sure to sell it to them for fair market value. When you transfer a property to a close family member, you will be deemed to have received fair market value even if you actually receive much less than that on the sale, meaning that you will still have to pay tax on the capital gain regardless of whether or not you have received any cash. Also, selling a property for less than fair market value can actually result in some double taxation, so speak to your tax specialist before transferring the property. If you want to spread out the capital gains tax (and make the payments more manageable for your children), consider making the payments payable over a 5 year period and claiming the capital gains reserve, so that only 20% of the capital gain is taxable in any one year.

If you are more comfortable with leaving the property to your kids in your will, one good way to alleviate the inevitable capital gains tax hit is with permanent life insurance. The death benefits are usually tax-free and can be used to cover capital gains and/or any other estate taxes – so your executor won’t be forced to sell your cottage or any other assets to pay taxes.

Your family cottage is an important part of your life. Make it an important part of your overall financial plan, too. Your professional advisor can help you make the right choices for your personal situation.

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