Mark Goodfield, the accountant behind The Blunt Bean Blog concludes the series on transferring the family cottage by outlining some ways to reduce the tax hit. Thank you for the excellent series, Mark. I sure learned a lot.

In today’s final blog in my three part series (Part 1 of the series is available here and Part 2 here) on transferring the family cottage, I will discuss some of the alternatives available to mitigate and defer the income taxes that may arise on the transfer of a family cottage.

Life Insurance

Life insurance may prevent a forced sale of a family cottage where there is a large income tax liability upon the death of a parent and the estate will not have sufficient liquid assets to cover the income tax liability. The downside to insurance is the cost over the years, which can be substantial. The cost of insurance over decades of potentially increasing premiums, all the while ensuring the insurance policy is large enough to cover the income tax liability, is problematic (alternatively one can wait until later in life to insure and take a chance on whether they can still obtain insurance). I would suggest very few people imagined the quantum of the capital gains they would have on their cottages when they initially purchased them, so guessing at the adequate quantum of life insurance required is difficult at best. Purchasing a large last to die insurance policy may do the trick; however, the ultimate insurance cost over time has to be balanced against taking those funds and investing them to cover off the future income tax liability.

Gift or Sale to Your Children

As discussed in the second blog, this option is challenging as it will create a deemed capital gain and will result in an immediate income tax liability in the year of transfer if there is an inherent capital gain on the cottage. The upside to this strategy is that if the gift or sale is undertaken at a time when there is only a small unrealized capital gain and the cottage increases in value after the transfer, most of the income tax liability is passed on to the second generation. This strategy does not eliminate the income tax issue; rather it defers it, which in turn can create even a larger income tax liability for the next generation.

If you decide to sell the cottage to your children, be advised the Income Tax Act provides for a five year capital gains reserve and thus, consideration should be given to having the terms of repayment spread out over at least over five years.

Transfer to a Trust

A transfer of a cottage to a trust generally results in a deemed capital gain at the time of transfer. An insidious feature of a family trust (check out this post another way to use the family trust to reduce income taxes) is that while the trust may be able to claim the principal residence exemption (“PRE”), in doing so, it can effectively preclude the beneficiaries (typically the children) of the trust from claiming the PRE on their own city homes for the period the trust designates the cottage as a principal residence.

If a parent is 65 years or older, transferring the cottage to an Alter Ego Trust or a Joint Partner Trust is another alternative. These trusts are more effective than a standard trust, since there is no deemed disposition and no capital gain is created on the transfer. The downside is that upon the death of the parent, the cottage is deemed to be sold and any capital gain is taxed at the highest personal income tax rate, which could result in even more income tax owing.

The use of a trust can be an effective means of sheltering the cottage from probate taxes. Caution is advised if you are considering a non-Alter Ego or Joint Partner Trust as on the 21st anniversary date of the creation of the trust, the cottage must either be transferred to a beneficiary (should be tax-free) or the trust must pay income taxes on the property’s accrued gain.

Transfer to a Corporation

A cottage can be transferred to a corporation on a tax-free basis using the rollover provisions of the Income Tax Act. This would avoid the deemed capital gain issue upon transfer. However, subsequent to the transfer the parents would own shares in the corporation that will result in a deemed disposition and most likely a capital gain upon the death of the last surviving parent. An “estate freeze” can be undertaken concurrently which would fix the parents income tax liability at death and allow future growth to accrue to the children; however that is beyond the scope of this blog.

In addition, holding a cottage in a corporation may result in a taxable benefit for personal use and will eliminate any chance of claiming the PRE on the cottage for the parent and children in the future.

In summary, where there is a large unrealized capital gain on a family cottage, there will be no income tax panacea. However, one of the alternatives noted above may assist in mitigating the income tax issue and allow for the orderly transfer of the property.

Readers are strongly encouraged to seek professional advice when dealing with this issue. There are numerous pitfalls and issues as noted above and the advice above is general in nature and should not be relied upon for specific circumstances.

[Note: See Mark’s comment in response to Earl about the concept of legal and beneficial ownership in the context of joint ownership with a right of survivorship. As Mark states, this area is a minefield, so please ensure you obtain proper legal advice before attempting to transfer a cottage into joint ownership with a right of survivorship.]

This article has 13 comments

  1. Nice series. Thanks for the info.

    What effect does adding your children to the title of the cottage have? (as in parents + children)
    Does this still result in a deemed disposition when the parents die?

  2. Hi Ivey,

    Good question, since it raises several issues. For discussion purposes, say you add two children to the title of the cottage. From an income tax perspective, the CRA would consider each parent to have disposed of ½ of their interest in the cottage upon the change in legal title. Thus, each parent would have a 25% deemed disposition. Clearly, adding children to the title, actually accelerates the recognition of the income tax liability and does not defer or avoid it. There would also be a deemed disposition of the parents remaining ownership of the cottage upon the death of the last surviving parent. Consequently, this is not a suggested solution.

    I have seen parents transfer title to their children to try and avoid probate taxes (I hope CC does not mind a little self promotion, but I will discuss probate misplanning next month on my own blog The Blunt Bean Counter). Where this has been done, a lawyer should be consulted to see if they can reflect the ownership as beneficial rather than legal to prevent the unintended income tax consequences. There have also been some probate cases that may or may not help in the case of a misguided title transfer.

  3. Thanks for the great series Mark.

    Unfortunately, my parents just sold their cottage (after 40 years), so this info won’t be relevant for me anymore. At least we won’t have any of the problems associated with the kids sharing a cottage.

  4. Thanks Mike.

    Your comment about your parents owning the cottage 40 years, made me think about something I did not note in the blogs. In 1994, Canadians were allowed to make a capital gains election upon the phase-out of the $100,000 capital gains election. Many people’s parents elected to bump the adjusted cost base of their cottage in 1994 to a higher value. Thus, upon disposition, you should check with your parents, their accountant or try and find their 1994 tax return if possible to see if they made such an election. I don’t think CRA will still have record of this election, as they most likely have destroyed such, but you can check.

  5. @Mark – Yes, I remember my parents getting an appraisal done for that purpose in 1994.

    My old man is extremely financial aware (to put it mildly). There is no way something like that would have slipped by him. 🙂

  6. @The Blunt Bean Counter

    I’ve been reading your blog for a month. It’s great! I’ve added it to my RSS feed.

  7. I see your point about the acceleration, but I would think in some cases (like the impending housing crash) might present a good time to make such a disposition. But then again housing dips don’t happen very often (20+ years or more apart)

  8. @Mike- I heard financial acumen skips a generation 🙂

    @Anon- Hi Mom, nice of you to drop by to CC’s blog

    @Ivey- The key take away is if there is not a large inherent capital gain, then a title transfer, sale or gift would not have a significant income tax impact.

  9. Pingback: Ways to Reduce the Tax Hit from the Family Cottage | The Montrealer-Real Estate Blog

  10. Timely article as I’ve been researching this issue.

    I have read elsewhere that a child can be added to the title of the cottage with no immediate tax consequences … i.e.,

    “It is possible to register title of the property in joint tenancy (each joint owner has an undivided interest in the entire property). This type of joint ownership with right of survivorship (JTWROS) means that upon the death of one owner the property is simply transferred directly to the surviving joint owner.
    You can enter into a JTWROS agreement with an individual, other than a spouse, without incurring an immediate tax liability. In order to accomplish this you have to ensure that you do not transfer beneficial title (use and enjoyment), in the asset during your lifetime, to the joint tenant at the time of entering into the agreement. If you intend to implement this strategy it may be prudent that you stipulate your intentions in writing at the time you enter into the JTWROS agreement.”

    My father is considering adding me to the title on his cottage and I would like to ensure that this could be done without triggering an immediate capital gain.

  11. Earl, I made reference to where you are going with this in my response to Ivey’s first question, but let’s expand. There were two Supreme Court cases in regard to joint accounts and evidence of intention and the related legal concept of presumption of resulting trust and advancement a few years ago; these cases seem to have clarified and muddied the waters at the same time. The legal concepts of these cases are far beyond my comprehension. Your quote about “joint ownership with right of survivorship (JTWROS)… but with no beneficial ownership” opens a huge can of worms.

    There seems to be some consensus in the tax world, that based on CRA statements, where there is a change in legal ownership without a corresponding change in the beneficial ownership, there may not be a disposition of the asset for tax purposes until the asset is actually sold or the transferor dies. This may also be effective for probate purposes, although it can create a plethora of other issues. But what you must understand is that, if this concept is accepted, the true owner is the beneficial owner (parents in your case), so splitting the ownership and leaving you only as a legal owner, leaves you without true ownership in the cottage as I understand it, and a boatload of possible unintended consequences.

    These concepts are extremely complicated and if you are contemplating making the cottage ownership joint without beneficial ownership, you must get legal advice, preferably from an estate or tax lawyer so you do not create other income tax, probate tax or estate tax issues.

    I found an article by a lawyer James Baird who attempts to explain the complexities of these notions should anyone wish to attempt to understand these fine legal distinctions

    I will not comment further on these concepts, since these are legal concepts beyond my scope of understanding. I have just commented to Earl to put the issues and concepts out there if anyone wants to discuss with a lawyer, but to me as a non-lawyer, it seems it may be better in many cases to keep the status quo, then risk the various other complications.

  12. Thanks Mark! I thought the strategy was being oversimplified elsewhere.

  13. Mark great piece that is very beneficial.
    I am curious about the sale of the cottage to a child with a promise to pay. I was told that this allows the parent to maintain control of the cottage but freezes the gain as of the sale date and the parent then has 5 years to pay the tax on the gain in a lump sum or equally over the 5 years.
    Lets assume more then 5 years goes by and the child never pays for the cottage and the last parent passes away, then forgives the debt(payment for the cottage) in the will, how does CRA see this?
    CRA would have recieved their taxes on the gain and now the child takes on the gain from the original freeze date. Your thoughts? Curious if this is an effective method to use. I am assuming as well that there would be land transfer taxes as well to consider upon the death.