Whether your cottage is opulent and mansion-like or a simple log cabin set deep in the woods, there’s a strong chance it’s grown in value since you bought it. That can be great news if you plan to sell your home away from home. But the appreciation can also add complexity if you plan to pass the cottage on to the next generation. Chris Gandhu, High Net Worth Planner with TD Wealth, joins Kim Parlee for a three-part series on cottage succession. In part two: Some ways to help manage appreciation and capital gains tax.
Part one: One big family asset
Part three: Estate planning in action
Print Transcript
- Welcome back to The MoneyTalk Cottage Show. Cottages and next generations can be tricky, so this entire show is devoted to that topic and how to structure things, and the things you need to think about it. Chris Gandhu is a high net worth planner with TD Wealth. He joins us now. And Chris, we were talking about ways to purchase a cottage and to structure that to make things easier, but you mentioned there's no silver bullets. Let's talk a bit about, for those who already have a cottage today, if you haven't yet planned for the passing on of your cottage, what would you say are the core issues?
- I mean, the 10,000 pound gorilla in the room is date of death tax, right? And you can't avoid it, but we know that at the passing of the second spouse bill, there's a big tax bill waiting for it, and I think you have to assess what the tax bill is and determine, do I have the liquidity to pay for that tax? Otherwise, come up with a plan. The estate is likely going to be forced to sell other assets to pay for the tax, or perhaps even sell the cottage to pay for the tax. So it is important to canvass these issues.
- Let's talk a bit about life insurance. I know you and I have talked about that before in terms of ways to help pay for that tax bill and not have to sell the cottage. How does that actually work?
- Right, so you know, as I said, you can't avoid this tax. You can perhaps minimize it and plan for it. So again, if you have an appreciating property, which likely a cottage is, maybe you want to minimize the tax by actually transferring ownership today, right? That way, you're locking in whatever appreciation you have, and the future appreciation goes to the new owner. But in either case, we're going to have some tax bill to pay for, and if you don't have any other assets to lean on, then perhaps insurance is a solution, because you can match the insurance to what your tax bill would be and it will pay out tax-free at your passing to cover that tax liability.
- You mentioned, and we talked earlier a bit about trusts. Trusts are-- there's more than one kind of trust. There's different ones that you can put together. So maybe tell me a bit about-- because what are the options and the impact on taxes and cash flow?
- Yeah, so there's a multitude of options out there, but typically, for cottage planning, you're either looking at a trust you set up during your lifetime, which is an inter vivos trust, or perhaps planning after you pass away using the testamentary trust. So for inter vivos trusts, the way Jeff has done, he put the property into the trust from day one. That is an option. For many folks, the trust might be something that comes up later on when they're talking about planning with their planner.
So to do that, the first thing you have to recognize is that when property goes into an inter vivos trust, there actually is a disposition. You own the property. Now, this trust is going to be the owner going forward. So that disposition is going to trigger tax. You want to find out how much that tax is, and are you going to pay that bill or perhaps you're going to use a principal residence exemption to shelter it. Putting into the trust from a tax perspective still may make sense, because if the future growth is going to be much larger than the appreciation that has already accrued, yes, you're accelerating some tax today, but you're deferring that future growth.
And in an ideal scenario, that probably gets passed on to the next generation, and they are the ones that are left with the tax bill, not you. Of course, setting up that trust today means there is a setup cost. There's ongoing compliance. And as I said, you may be accelerating the tax. Sometimes, for Canadians that are 65 and over, there's other criteria there, but that's the big one is that each, there is the option to use an alter ego trust, which again is a specific type of an inter vivos trust.
And if that option applies to you, guess what, there's no tax on the way in. So that's certainly an option to look at for those that qualify. And finally, if you don't pass the property, either by trust or otherwise to the next generation today and you'd rather pass it through the will, you can always incorporate a trust inside your will. So rather than saying I pass it to my child outright, I pass it to my child in trust, and that's what a testamentary trust is.
- Interesting. Awesome. I'm sure lots of options people maybe have not thought about, and good ones to consider. One thing that I wanted to ask is that this all works-- I think there's obviously provincial laws, and you have to kind of work within that, but what if you're outside of Canada, and what if the property is outside of Canada? How does that complicate things?
- Yeah, that's a very good question. So any time you have land in any other jurisdiction, that foreign jurisdiction is always willing to assert its right to tax that land. So typically, what you're dealing with is dual compliance, and probably double tax filings at the date of death. Now, if Canada happens to have a tax treaty with that foreign jurisdiction, typically, the double compliance won't lead to double tax because there's a foreign tax credit mechanism and remit a foreign tax, but CRA will give you credit for the foreign tax paid.
But although that works well in theory, sometimes it doesn't work well in practice. And the best example is our neighbors to the south. In fact, most Canadians, if they don't own cottage property here, they probably own one in the US. In the US, they have a unique date of death tax regime, which is actually a property transfer tax at death. So they're taking a haircut off the top, no correlation to any gain or losses, and the tax rate is quite high. It's 40%.
So let's just use Jeff's example. If his cottage is worth $1.5 million, and he happened to own it in the US outright, well, he's looking at 40% in tax, so about $600,000 in tax in the US, and as we discussed, maybe $250,000 tax in Canada. So sure, there's a foreign tax credit, but the US tax far outweighs Canadian. So they are unique cross-border issues to worry about, and this is certainly some planning that you should discuss with your advisor ahead of time.
- All right, Chris. Thanks so much. When we come back, we've talked about buying the cottage, how to structure it. We talked a bit about taxes. We're going to get a little deeper into how you actually structure things right after this.
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- I mean, the 10,000 pound gorilla in the room is date of death tax, right? And you can't avoid it, but we know that at the passing of the second spouse bill, there's a big tax bill waiting for it, and I think you have to assess what the tax bill is and determine, do I have the liquidity to pay for that tax? Otherwise, come up with a plan. The estate is likely going to be forced to sell other assets to pay for the tax, or perhaps even sell the cottage to pay for the tax. So it is important to canvass these issues.
- Let's talk a bit about life insurance. I know you and I have talked about that before in terms of ways to help pay for that tax bill and not have to sell the cottage. How does that actually work?
- Right, so you know, as I said, you can't avoid this tax. You can perhaps minimize it and plan for it. So again, if you have an appreciating property, which likely a cottage is, maybe you want to minimize the tax by actually transferring ownership today, right? That way, you're locking in whatever appreciation you have, and the future appreciation goes to the new owner. But in either case, we're going to have some tax bill to pay for, and if you don't have any other assets to lean on, then perhaps insurance is a solution, because you can match the insurance to what your tax bill would be and it will pay out tax-free at your passing to cover that tax liability.
- You mentioned, and we talked earlier a bit about trusts. Trusts are-- there's more than one kind of trust. There's different ones that you can put together. So maybe tell me a bit about-- because what are the options and the impact on taxes and cash flow?
- Yeah, so there's a multitude of options out there, but typically, for cottage planning, you're either looking at a trust you set up during your lifetime, which is an inter vivos trust, or perhaps planning after you pass away using the testamentary trust. So for inter vivos trusts, the way Jeff has done, he put the property into the trust from day one. That is an option. For many folks, the trust might be something that comes up later on when they're talking about planning with their planner.
So to do that, the first thing you have to recognize is that when property goes into an inter vivos trust, there actually is a disposition. You own the property. Now, this trust is going to be the owner going forward. So that disposition is going to trigger tax. You want to find out how much that tax is, and are you going to pay that bill or perhaps you're going to use a principal residence exemption to shelter it. Putting into the trust from a tax perspective still may make sense, because if the future growth is going to be much larger than the appreciation that has already accrued, yes, you're accelerating some tax today, but you're deferring that future growth.
And in an ideal scenario, that probably gets passed on to the next generation, and they are the ones that are left with the tax bill, not you. Of course, setting up that trust today means there is a setup cost. There's ongoing compliance. And as I said, you may be accelerating the tax. Sometimes, for Canadians that are 65 and over, there's other criteria there, but that's the big one is that each, there is the option to use an alter ego trust, which again is a specific type of an inter vivos trust.
And if that option applies to you, guess what, there's no tax on the way in. So that's certainly an option to look at for those that qualify. And finally, if you don't pass the property, either by trust or otherwise to the next generation today and you'd rather pass it through the will, you can always incorporate a trust inside your will. So rather than saying I pass it to my child outright, I pass it to my child in trust, and that's what a testamentary trust is.
- Interesting. Awesome. I'm sure lots of options people maybe have not thought about, and good ones to consider. One thing that I wanted to ask is that this all works-- I think there's obviously provincial laws, and you have to kind of work within that, but what if you're outside of Canada, and what if the property is outside of Canada? How does that complicate things?
- Yeah, that's a very good question. So any time you have land in any other jurisdiction, that foreign jurisdiction is always willing to assert its right to tax that land. So typically, what you're dealing with is dual compliance, and probably double tax filings at the date of death. Now, if Canada happens to have a tax treaty with that foreign jurisdiction, typically, the double compliance won't lead to double tax because there's a foreign tax credit mechanism and remit a foreign tax, but CRA will give you credit for the foreign tax paid.
But although that works well in theory, sometimes it doesn't work well in practice. And the best example is our neighbors to the south. In fact, most Canadians, if they don't own cottage property here, they probably own one in the US. In the US, they have a unique date of death tax regime, which is actually a property transfer tax at death. So they're taking a haircut off the top, no correlation to any gain or losses, and the tax rate is quite high. It's 40%.
So let's just use Jeff's example. If his cottage is worth $1.5 million, and he happened to own it in the US outright, well, he's looking at 40% in tax, so about $600,000 in tax in the US, and as we discussed, maybe $250,000 tax in Canada. So sure, there's a foreign tax credit, but the US tax far outweighs Canadian. So they are unique cross-border issues to worry about, and this is certainly some planning that you should discuss with your advisor ahead of time.
- All right, Chris. Thanks so much. When we come back, we've talked about buying the cottage, how to structure it. We talked a bit about taxes. We're going to get a little deeper into how you actually structure things right after this.
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