Today’s guest post is Part 1 of a 3-part series on estate planning issues surrounding the family cottage, courtesy of Mark Goodfield, a professional accountant who writes the The Blunt Bean Counter Blog. Mark covers accounting, tax and wealth management issues on his blog and if you haven’t checked out his site, please do so. It is excellent. Now, over to Mark…

This is the first blog in a three part series on transferring the family cottage. Today’s blog will deal with the historical nature of the income tax rules, while the second blog will deal with the income tax implications of transferring or gifting a cottage and finally in the third blog, I will discuss alternative income tax planning opportunities that may mitigate or defer income tax upon the transfer of a family cottage.

Canadians love their cottages. They are willing to put up with three hour drives, traffic jams, never ending repairs and maintenance and constant hosting duties for their piece of tranquility by the lake. However, I would suggest the family cottage is one of the most problematic assets for income tax planning purposes, let alone the inherent family politics that are sure to arise.

For purposes of this blog, I will just assume away the family politics issue. I will assume the children will each grab a beer, sit down at a table and work out a cottage sharing schedule to everyone’s satisfaction and while they are at it, agree on how they will share the future ownership of the cottage when their parents transfer the cottage or pass away. I would say a very realistic situation in Canada, not!!!

Let’s also dismiss any illusions some may harbor that they can plan around the taxation issues related to cottages or even avoid them entirely. I can tell you outright, there is no magical solution to solving the income tax issues in regards to a family cottage, just ways to mitigate or defer the issues. Many cottages were purchased years ago and have large unrealized capital gains.

So let’s start by taking a step back in time. Prior to 1981, each spouse could designate their own principal residence (“PR”) which, in most cases, made the income tax implications of disposing or gifting a family cottage a null and void issue. The principal residence exemption (“PRE”) in the Income Tax Act essentially eliminated any capital gain realized when a personal use property was sold or transferred. Families that had a home in the city and a cottage in the country typically did not have to pay tax on any capital gains realized on either property when sold or gifted.

However, for any year after 1981, a family unit (generally considered to be the taxpayer, his or his spouse or common-law partner and unmarried minor children) can only designate one property between them for purposes of the PRE. Although the designation of a property as a PR is a yearly designation, it is only made when there is an actual disposition of a home. For example, if you owned and lived in both a cottage and a house between 2001 and 2011 and sold them both in 2011, you could choose to designate your cottage as your PR for 2001 to 2003 and your house from 2004 to 2011 or any other permutation plus one year (the CRA provides a bonus year because they are just a giving agency :)).

In order to decide which property to designate for which years after 1981, it is always necessary to determine whether there is a larger gain per year on your cottage or your home in the city. Once that determination is made, in most cases it makes sense to designate the property with the larger gain per year as your personal residence for purposes of the PRE.

Click here to continue to the next post in the series on income tax issues surrounding the transfer of a cottage.

This article has 12 comments

  1. Pingback: Transferring the Family Cottage: Tax Issues | Canadian Capitalist

  2. Pingback: Transferring the Family Cottage: Tax Issues « MoneySense

  3. Pingback: Ways to Reduce the Tax Hit from the Family Cottage | Canadian Capitalist

  4. Helpful article.

    I had similarly advised my father that the PRE could be used to shield the gain on his cottage, since it has appreciated far more than his home, and he has occupied it annually on a seasonal basis. His lawyer advised him against making such an election, claiming that CRA will challenge the PR election where the cottage was occupied for less time than the home during the year. Have you heard of CRA mounting a challenge on this basis? I can find no such cases and no rules to this effect, and I am concerned that my father is not receiving sound tax planning advice from this lawyer.

  5. Pingback: LinkStuff – Easter Egg Hunt Edition

  6. I think I may have answered my earlier question. I now think that the lawyer advising my father is confusing “primary residence” for GST/HST purposes with “principal residence” for Income Tax Purposes. The CRA clearly states in paragraph 5 of Interpretation Bulletin IT-120 that a cottage will be considered to meet the “ordinarily inhabited” rule even if it is only occupied for vacation periods.

    I have uncovered another question though. While CRA states that a PRE designation need not be filed until the disposition of a property, my father has been claiming property taxes on his home for the Ontario property tax credit, which includes a declaration of his home as principal residence. I am considering assisting him to re-file his tax returns for previous years to not only claim the higher amount of taxes paid on his cottage, but to also avoid jeopardizing a PRE designation on the cottage on disposition. Do you know if the Ontario property tax declaration has a bearing on the PR election on disposition?

  7. And why can’t you just put your kids name on house ownership?

  8. Earl and Farhan, sorry, for some reason I did not get notification of your questions, I may have forgotten to tick the notify me box on Part 1 of the series.

    @Farhan- see parts 2 & 3, I discuss the various income tax implications of doing as you suggest.

    @ Earl–you are correct about the cottage. I have some concern about the advice your dad is receiving.

    In respect of the property tax credit, Ontario says “You cannot claim a property tax credit for more than one Ontario residence, such as a house and a cottage, for the same period. However, you can claim more than one principal residence if you have lived in more than one at different times in the year, and your total period of principal residence occupancy does not exceed 12 months”. So it appears Ontario contemplates you having two PR and the Federal election upon sale contemplates more then 2 PR’s. Thus, I dont see how you would jepordize the PR claim by the prior Ont filing. In fact, I think by refiling you risk Onario looking into the credit claim, you may want to let sleeping dogs lie.

  9. Thanks Mark. I’ll be advising my Dad to look for a lawyer with more expertise in this area.

  10. Wow.. so actually is the best advice to put your child on the home ownership when you purchase the cottage? Is that possible?

  11. Farhan, I am not sure how you come to the conclusion I say that is the best advice. I provide various alternatives that depending upon specific circumstances may be effective. If you are buying or transferring a cottage, it is a signficant asset and you should engage a professional to provide advice based on your specific needs and circumstances.

  12. What is best, my mom is 85 she has left the cottage to my three daughter. I am the daughter and am living at the cottage presently. I do not own a home. My mother has a duiplex to which she lives in, upstairs is one tenant. Do you think its a good idea and will the tax be less when she passes and what is the percentage. Each of my daughters own a home or a condo. Please help can you answer in my e mail thank you

Leave a comment

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>