Cottage season is upon us. One thought that may be on your mind this summer is how you will eventually pass the family cottage down to your children. Anthony Okolie speaks with Nicole Ewing, Director, Tax and Estate Planning, TD Wealth, about different approaches and tax implications to keep in mind.
* You're probably going to be spending a lot of time at the family cottage this summer. And as you sit on the dock, taking in the lake and breeze, you may start thinking about how you're going to eventually pass the property down to your children. Nicole Ewing, director of tax and estate planning with TD Wealth, joins me now with what to consider so the process is a seamless one. Nicole, thank you very much for joining us today.
* It's my pleasure.
* So people want to pass down their assets in a will. But they're afraid of the tax consequences. Walk us through what some of the consequences might be if you do decide to pass down the cottage through your will.
* So it's wonderful that we have people who are thinking about what the tax liability might be, because it's often something that's missed and forgotten about and, unfortunately, leads to not so great results because there's a huge tax bill, potentially, that could be coming on the death of an individual.
So if you've purchased your cottage and you have owned it for a number of years, it's likely gone up in significant value. And on your death, you're going to be deemed to have sold that at fair market value. And you'll be responsible for capital gains tax on the difference between the cost base and the fair market value.
So the cost base includes the purchase price, which is presumably much lower than it would be now. It also includes-- hopefully, you've kept some receipts your executor can use to add any significant additions that were done to the property to increase that cost base. But ultimately, you'll be paying tax on the difference between the cost base and the fair market value, 50% of which is included in your tax bill. And it can be quite significant.
* So clearly, passing that down the cottage is more complicated than just simply putting it through your will. Would selling it to your kids be easier, because people want less complication in their lives as much as possible? So would this approach accomplish that?
* Well, I'll say it depends on your family circumstances and a whole bunch of other factors. But we need to be mindful. If we are selling the cottage to our children, we must do that at fair market value. If you sell it to a non-arm's-length individual for less than fair market value, it is the worst possible tax result because you will still be deemed, for tax purposes, to have sold it at the current fair market value and pay tax on the difference between your cost base and the current value. But your children, who paid less than the fair market value, are not going to get the benefit of that bumped-up cost base. They will, instead, have to pay tax using your cost base. And so this is going to potentially result in double taxation and them paying tax on the same amount, which is completely undesirable.
* Not something you want to be doing.
* We want to avoid that as much as possible. And so we look at the other options that might be available. You could sell the property outright and just give the proceeds to your children. You could have them purchasing the property from you, as I say, at fair market value and potentially taking back a promissory note for a portion of that. You could potentially forgive that promissory note in your will, which would allow for a bit of savings there. And you could potentially, if you are selling it to your children, do that over a number of years, take advantage of the rule that allows you to spread your capital gains over a number of years. And you would take a portion of the purchase price over that period of time and only be paying tax on the amount that you received in the year.
So there's a number of strategies. We can also use trusts to pass things down as another effective way of doing things. But there-- it really will depend on your personal circumstances.
* Now, you mentioned trusts. What do people need to know about holding a cottage in a trust and the implications when you're passing down that cottage to the next generation? Talk us through the advantages and disadvantages of this strategy.
* So there are different types of trusts that might be able to be used. So the typical one that we would be thinking about is the family trust. That's a trust that you create during life. You transfer property into it for the benefit of other individuals. When you transfer that property into a trust, that is a deemed disposition for tax purposes. So if I'm transferring my cottage into a trust today, I'm paying that capital gains tax now.
Now, you might want to do that because it allows you to pay that tax and lock in and freeze that value so that upon your death, you know exactly that you've already covered the bill. And the future gain would go to the recipients of the-- in the trust. So that's one way of doing it.
And if you have-- I would suggest that you-- trusts are great in that they allow you to outline the rights and responsibilities. You can put in there terms about usage or the requirement to enter into a more comprehensive co-ownership agreement. You can detail which rights people have. So are they able to pass it down to their children and/or have other people attending? You can really work out all of the nitty-gritty details of owning that property. And particularly where there's multiple individuals who are owning it, it can be very useful.
The other type of trust that people might be thinking about, the Alter Ego or joint partner trust-- that's available for individuals who are over 65. They can transfer the cottage into the trust and have no immediate tax liability. So this, essentially-- flow through into the trust. And then the terms of that trust will allow you, again, to outline who the beneficiaries would be. It can essentially act as a bit of a post-nuptial agreement between spouses. It does avoid some of the risks of having a will challenge in certain provinces that's more likely than in others. And a trust really is a little bit more-- it gives you more certainty of result.
* So if you add kids as joint owners when you first get the cottage, does that make passing it down easier or more complex?
* It really depends on what other documents you put in place when you added your children as joint owners because there are rules in Canada about capital property. And essentially, you can have two different types of ownership-- legal and beneficial. And when you own property with your children, the presumption is that was done for convenience purposes only, to ease administration. Your children are actually-- their name is on title. But they're not actually beneficial owners of this property. On your death, your children will essentially be deemed to be holding that property in trust for your estate.
So we haven't gotten-- we haven't avoided any of the tax consequences. We haven't avoided any of the potential issues that could arise there as well. Really, we need to be thinking about the bigger picture, what other documents-- if you had it very clearly that your children are, in fact, owners-- beneficial owners-- then you would only be responsible for the tax on the amount of the property that you owned. But we really need to have documentation for that to make CRA comfortable that this wasn't something that was not done properly.
So we need to step back and think about, as well, some of the risks of doing that-- is it could potentially be exposed to creditors. It could be exposed to family law claims. Your children could potentially want to sell their interest in it. So a lot of issues to consider. Again, making sure that you have thought all of those options through, you've had professional advice to be able to help guide you through that, will be very important.
* So you can understand all the consequences, not just taxes, but other consequences of your decision?
* Exactly. It's always a bit of a trade-off when it comes to tax. You can lower your taxes. But there's going to be something else that might make things a little bit more complicated.
* Nicole, great information, as always. Thank you very much for joining us.
* My pleasure.