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Keeping the Family Cottage

Submitted by Brendan Donahue & Sara Worley

Investment Advisors, Manulife Securities Incorporated 


        The family cottage can be a source of enjoyment for many people, but it can also cause estate planning headaches for those who want their children to inherit the property. In some cases, property values may have risen so high that the children are forced to sell the cottage to pay the capital gains tax owing. 

        While it’s difficult to completely avoid capital gains tax on vacation property, there are some ways to help minimize the burden.


Principal Residence Exemption

        Those who expect their vacation home to rise in value faster than other residential properties may wish to deem the vacation property their principal residence. For the time period in which the vacation property was one’s principal residence, it would be exempt from capital gains tax when the property is sold or changes ownership. 


Maximize the ACB

        The adjusted cost base (ACB) of real estate is the amount paid to acquire the property, plus any capital improvement costs. As a capital gain is the difference between the proceeds of disposition and the adjusted cost base (purchase cost plus capital costs), raising the ACB of a property reduces its future capital gain. 


        Adult Children

Adult children are also entitled to their own principal residence exemption; however, this would involve at least a partial transfer of ownership, which would mean that the property would be exposed to any lawsuits, marital breakdowns or the like that the adult child may be involved in. Secondly, the portion transferred to the child would result in a deemed disposition at market value, triggering capital gains.


Capital Gains Exemption

        Properties bought before 1982 could qualify for a capital gains exemption. For example, if spouses owned two properties which were purchased before 1982, they can each claim sole ownership of one of the properties, therefore sheltering two properties from capital gains tax.


Transfer the Cottage Now

        Some people opt to pass on the vacation cottage during their lifetime instead of waiting for it to go through their Will, but there are pros and cons to both strategies. By retaining ownership, parents can defer taxation until the death of both spouses and protect the cottage from the child’s creditors or their former spouses.

        Shifting ownership while parents are alive, however, has some advantages. After paying capital gains thus far, it allows future capital gains to be deferred further in the future. It also allows parents to avoid probate fees on the cottage and simplify their lives.

        There are a few ways to go about it. The property could be gifted to one’s children, but the transaction would take place at fair market value in the eyes of Revenue Canada, even if no money was exchanged. Additionally, when the children eventually sell or pass on the cottage, they will have a cost base equal to the amount paid, possibly resulting in double taxation. 

        If the cottage is sold rather than gifted, it could be done so using a demand mortgage with deferred payments, which could spread capital gains tax over 5 years. On death, the mortgage could be forgiven in one’s Will and their children could acquire the cottage with no debts and taxes payable.

        Rather than transferring ownership of the property directly, the cottage can be moved into a trust. Just like the other scenarios, the transfer results in a deemed disposition of the cottage at its fair market value, causing capital gains tax to be payable. The trust can remain open for 21 years after which its capital property will be deemed to be disposed, triggering capital gains tax. Tax may be avoided, however, if at least one beneficiary of the trust ordinarily inhabits the cottage.  


Final thoughts

        While these strategies may seem straightforward, they are not suitable for everyone. It would be wise to discuss all strategies in advance with an accountant or lawyer to determine suitability.