Transferring the Family Cottage: Tax Issues
In today’s post Mark Goodfield, a professional accountant and the writer behind the excellent Blunt Bean Blog, continues the series on estate planning issues surrounding the family cottage. Click here for Part 1 of the series.
In my first blog in this three part series on transferring the family cottage, I discussed the fact you can only designate one property as a principal residence per family after 1981. In order to explore the income tax implications associated with transferring ownership of a cottage, I will assume both a city residence and a cottage have been purchased subsequent to 1981 and I will assume that the principal residence exemption has been fully allocated to your city home and the cottage will be the taxable property.
Many parents want to transfer their cottage to their children while they are alive, however, any gift or sale to their children will result in a deemed capital gain equal to the fair market value (“FMV”) of the cottage less the original cost of the cottage, plus any renovations to the cottage. Consequently, a transfer while the owner-parent(s) is/ are alive will create an income tax liability where there is an unrealized capital gain.
Alternatively, where a cottage is not transferred during one of the parent’s lifetime and the cottage is left to the surviving spouse or common-law partner; there are no income tax issues until the death of the surviving spouse/partner. However, upon the death of the surviving spouse/partner, there will be a deemed capital gain, calculated exactly as noted above. This deemed capital gain must be reported on the terminal (final) tax return of the deceased spouse/partner.
Whether a gift or transfer of the cottage is made during your lifetime, or the property transfers to your children through your will, you will have the same income tax issue, a deemed disposition with a capital gain equal to the FMV of the cottage less its cost.
It is my understanding that all provinces with the exception of Alberta, Saskatchewan and parts of rural Nova Scotia have land transfer taxes that would be applicable on any type of cottage transfer. You should confirm whether land transfer tax is applicable in your province with your real estate lawyer
So, are there any strategies to mitigate or alleviate the income tax issue noted above? In my opinion, other than buying life insurance to cover the income tax liability, most strategies are essentially ineffectual income tax wise as they only defer or partially mitigate the income tax issue. In my final blog installment of this series, I will summarize the income tax planning options available to transfer the family cottage.