You, Your Cottage & The Tax Man

Very informative article from Money Sense Magazine by Julie Cazzie this month about the tax implications of leaving the family cottage to the kids. Excerpted here, find full article at http://www.moneysense.ca/2010/11/24/top-5-tax-myths-about-leaving-property/

If you spend enough time at family barbecues, eventually the talk will turn to ingenious ways to dodge the tax man when leaving property to the kids. Many of these schemes, such as making your offspring co-owners of your cottage or giving the cottage to your kids while you’re still alive, sound like they should work. But usually they don’t. That’s because the Canada Revenue Agency (CRA) has seen it all before, and they closed most of the loopholes long ago.

While you should definitely take advantage of the one big exemption you do have—that you don’t have to pay capital gains taxes on your principal residence—most of the other dodges you hear about won’t work the way you hope. We’ve listed a few of them below, to save you the trouble:

Myth #1: I can avoid paying capital gains taxes by making my child a co-owner.
Nope. If you add a child’s name to the title for your cottage or home, the CRA views that event as a taxable disposition of 50% of your property at fair market value. The capital gains taxes on that portion are due right away, says Kathy Munro, a tax partner with PricewaterhouseCoopers in Toronto. When you and your spouse die, if you leave your portion of the cottage to your child, your estate will have to pay capital gains taxes on the remaining 50% then.

Myth #2: I know there’s a $100,000 capital gains exemption. Where do I sign up?
You can’t. The $100,000 capital gains exemption was taken away in 1994. At that time, if you owned property other than your principal residence and you elected to increase the cost base of a second property, such as the family cottage, you could have triggered the $100,000 exemption. If you didn’t elect this option by 1994, it’s too late. However, if you are receiving property from your parents, always check to see if they applied for the exemption.

Myth #3: I’ll just give the cottage to my daughter. If there’s no sale, then there’s no taxes payable.
Unfortunately, the CRA found a way around that one too. It treats gifting as a deemed disposition of property on the day the cottage was gifted and capital gains taxes are due at that time. The CRA will assume the cottage was gifted at fair market value, to be determined by a tax or real estate valuator.

Myth #4: I can only declare my home as my principal residence.
Not true. As long as you lived in both your home in the city and your cottage in the country for at least a few weeks each year, you can elect either one as your principal residence. The key, though, is that you can only have one principal residence at a time. Thus, if your home had higher capital gains during the period from 1972 to 1985, and your cottage had higher capital gains during the period from 1986 to the present, you could claim your home as your principal residence during the earlier period and your cottage during the latter period to minimize your taxes. But the periods can’t overlap.

Myth #5: I can avoid probate charges by putting the cottage in trust for the kids.
Okay, this one isn’t a myth, it’s true—but, alas, unless you claim the cottage as your principal residence, you will still have to pay capital gains taxes. This is a real shame because probate fees, which range up to 1.5% of the value of the estate, are nothing compared to capital gains taxes, which can be as high as 47% of the taxable portion of the capital gain. So while you can avoid probate by setting up a trust, be careful that you don’t spend more on lawyers than you would actually save on the probate fees, which are often just a few thousand dollars