Cottage Planning: How Many Rooms Will Tax Take?
Enjoying the summer cottage is a Canadian tradition. Do you know what your cottage is worth? According to David Christianson, this week’s guest columnist, a valuation this year might be a good idea, as high cottage values could bring succession challenges.
Many cottage owners may be unaware that there will be a tax hit when they sell or transfer the cottage or when they die.
In past generations, it was much less challenging to pass the cottage on to the kids. Until 1972, there was no tax on capital gains and before 1982 the principal residence exemption could be claimed by both spouses. This meant that a couple could actually have two principal residences eligible for tax-free gains on a sale or gift.
Now, a married or common-law couple is only allowed one principal residence exemption. Therefore, if both residences are sold, the gain on one sale or transfer may be tax free, but the gain on the other will attract tax, if it has increased in value.
Remember that 50% of the gain on a capital asset must be included in income in the year of sale, or in the year of death if there’s no surviving spouse. The taxable portion is taxed at the taxpayer’s marginal tax rate.
If you gift the cottage to an adult family member, this is still a deemed disposition for tax purposes, as the family member is not dealing with you “at arm’s length.” The same holds true if you transfer it to a trust for the benefit of your family or to a corporation that you control.
By the way, if you are ever gifting away a property, make sure your lawyer does NOT transfer it for a dollar, or that one dollar becomes the cost base for the next sale. Make sure it is a gift and not a sale for a dollar. (As long as it is a gift for zero consideration, then the person who receives it can use the fair market value at time of gift as the cost base to calculate future gifts.)
If you sell to a third party for full value, though, the tax on the gain is covered by the proceeds of the sale. However, gifts do not generate cash, but there still may be tax to pay. You need to have that cash on hand to pay the taxes.