As summer draws closer, lakeside cottage living beckons –and financial advisors are wise to consult with clients keen on buying or passing along their vacation homes.
As cottages are usually not designated as principal residences, confusion can arise when it comes time to sell or pass onto family down the road. It’s an issue that requires careful tax and estate planning from the get-go, says Christine Van Cauwenberghe, vice president of Tax and Estate Planning at Investors Group
“I think the question we get most frequently is, ‘How can I pass the cottage on in the most tax effective manner?’” she says. She adds that most people tend to fixate on probate fees, when that focus should be placed on income tax requirements, which can be 50% of the cottage’s value – regardless if it stays in the family.
“Generally speaking, when you pass on an asset to someone other than your spouse, there’s going to be a triggering of any unrealized capital gain,” she says. “So I you paid $300,000 for your cottage and it’s not worth $500,000, there could be capital gain of $200,000 there, half of which is taxable.
When calculating that gain, that you’re using your true cost base. So if you paid $300,000 for it, but you put in a $150,000 renovation, then the cost base is actually $450,000. You need to keep your receipts and accurately calculate your cost base.”
She says an education gap exists among cottage owners, who often assume they can simply pass their cottage on to their children without issue. In many cases, parents will try to manipulate the transfer value of a sale within the family – a tact Van Cauwenberghe warns can have consequences.
“So they say, ‘Fine, I’ll sell it to my child for a dollar.’ But when you’re non-arms length, you’re deemed to have received full market value, and so you’ll be deemed to have received $500,000 when you only received a dollar,” she says. “That strategy can really come back to haunt you, because then the child’s cost base is a dollar.”
Financial advisors play a key role in setting up an effective tax or succession planning strategy for cottage owners, Van Cauwenberghe says.
“For most people, the issue isn’t avoiding the tax, it’s funding the tax, and making sure there’s enough liquidity in the estate to make sure all things can happen,” she says. “And until you’ve met with your financial advisor or your insurance provider, it’s a bit of a guessing game as to whether enough will be there.
“Everyone has different definitions of what’s enough – so you need to do those projections with your financial advisor and then figure out what’s required.”
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