December 3, 2013 – Personal Income Tax October 2011 Dear Client, Welcome to my blog! The old format of my newsletters discussing both Small Business Needs and Personal Income Tax will now each be posted as an alternating new blog to my website periodically. As promised in my last newsletter, I was going to discuss planning for the succession of the family cottage and tax implications, and my first blog uses a decision tree to help you with that.
Personal Income Tax – Family Cottage Transfer Decision Tree for the Family Cottage Transfer
Transfer the cottage today while you are alive, or after your death?
If you transfer the cottage while you are alive, do you a) gift it to your children b) sell it to your children c) sell it to someone outside the family d) transfer it to a trust?
If you transfer the cottage after your death, how do you do bequeath it?
Let’s look at the issues and tax implications associated with each of these steps of the decision tree: Transfer the cottage today while you are alive, or after your death?
If the cottage has appreciated in value, there could be capital gains tax to pay, whether the cottage is transferred while you are alive, or after your death.
The principal residence exemption can be used to minimize the capital gains tax on the cottage.
If you transfer the cottage while you are alive, any future growth in value of the cottage after the transfer will be taxed in the hands of the new owners, thus deferring tax that would have otherwise been paid out of your estate, which would have reduced the inheritance of your heirs.
If you transfer the cottage while you are alive, the cottage will no longer be part of your estate and subject to Ontario probate fees when you die.
If you transfer the cottage while you are alive to your children, you can witness them enjoy both the benefits and responsibilities of ownership.
If you transfer the cottage while you are alive, do you gift it or sell it to your children?
If you gift the cottage to the children your retirement fund is reduced as you are not getting any proceeds for the gifting of the cottage, plus you could be faced with capital gains tax to pay.
If you sell the cottage to your children it must be sold for the fair market value of the cottage, nothing less, otherwise there will be a double tax problem (more to say on this in another blog).
If you sell the cottage to your children for the fair market value, your children could find financing to pay you in full, or you could take back a mortgage or promissory note for the balance owing.
Taking back a mortgage will allow you to spread the capital gains tax owing over a maximum period of five years
You could forgive the promissory note or mortgage at the time of your death with no adverse tax consequences.
If you transfer the cottage while you are alive, do you sell it outside the family?
The cash proceeds from the sale of the cottage outside the family is much easier to divide upon your death among your children, as the capital gains tax has been taken care of while you are alive, and the sharing of the benefits and responsibilities of cottage ownership after you die is not an issue.
If you transfer the cottage while you are alive, do you transfer it to a trust?
A trust is created when a person (called the settlor) transfers the title of a property to the trustee who holds and manages it for the benefit of the beneficiaries.
If you transfer the cottage while you are alive to a trust this will allow you to maintain control over the cottage during your lifetime.
If the beneficiaries are minor children, or are not capable of sharing the time and costs to manage the cottage, transferring the cottage to a trust and maintaining control resolves these issues.
Again, there could be capital gains tax on the transfer of the cottage to the trust; however, a transfer to an “alter-ego trust” can defer the capital gains tax (more to say on the “alter-ego trust” in another blog)
Probate tax will be avoided if the cottage is transferred to a trust as property held in a trust is not part of an estate subject to a will that must be probated.
If you transfer the cottage after your death, how do you bequeath it?
If your spouse is alive after your death, the cottage can be bequeathed to your spouse and there are no adverse tax consequences, as assets transferred to surviving spouses are rolled over on at tax free basis.
When the surviving spouse dies, the cottage can be bequeathed to all the children, and this would make sense if there is consensus on sharing of the benefits and costs of cottage ownership.
It is important to determine who is interested in sharing the benefits and costs of the cottage, and a solution may be to bequeath it to certain heirs that care for the cottage, and equalize the inheritances of the other heirs with other assets.
The inheritance pool of the other heirs will be reduced by the capital gains taxes and probate fees that will be paid out of the estate for the transfer of the cottage, so planning must be done for a fair and equitable distribution to the other heirs.
If you instruct the sale of the cottage in your will, the proceeds will be distributed according to your wishes after the payment of taxes.
If you gift the cottage in your will to a registered charity you may reduce the capital gains tax by designating a value that is less than the appreciated value.
This reduced value would be the eligible value used to determine the donation tax credit, which can be claimed on your final deceased tax return.
Stay tuned… My next blog will be related to Small Business Needs and will discuss the strategy behind salaries and dividends as compensation to owners of companies. Notice to Reader Dean Constand C.G.A. publishes this newsletter for information purposes only. Feel free to distribute to colleagues and friends. Although the material has been carefully prepared, it is not a substitute for professional advice.