Passing Down the Cottage Lifestyle
There is something magical about soaking your feet off the end of the dock, sleeping the afternoon away in a hammock, or helping the kids make their first s’mores. If you have a cottage you know exactly what I mean. A cottage is a place of dreams, hope and wonder. It brings the family together away from the stress and strain of city life and creates a lifestyle you want to pass on to your children and grandchildren and so on. But have you taken the necessary steps to ensure this peaceful oasis will be enjoyed for generations to come?
Many families have cottages that have been passed down for years. This seems like an idyllic tradition. However, passing a cottage on to your heirs may cause them a financial strain, possibly forcing them to sell. Due to the incredible inflation of real estate pricing in cottage country, it is not unheard of for a cottage that was worth $30,000 when transferred to the current owner to now be worth $300,000. While this looks great on the personal balance sheet, it creates a real problem for the current owner’s beneficiaries.
There is no estate tax in Canada. However when an individual dies all assets are deemed disposed. This means in terms of taxation you sell all of your assets the day you die and all resulting taxable income is added to your tax return for that year. How does this affect your cottage? Well with the example above you have a $300,000 cottage that has an original (to you) cost of $30,000. That means there is a $270,000 capital gain. Since the cottage is not your principal residence, this capital gain is taxable. Capital gains are currently only 50% taxable which means $135,000 is going to be added to the income you have already received from pensions, working, any RRSP balances, among other things. If we use a $50,000 taxable income and $150,000 balance in RRSP, adding the capital gain of $135,000 brings your taxable income to $335,000 for your final tax return. At 47% tax rate your estate needs to pay approximately $155,000 in taxes. Where is this money going to come from? Very often beneficiaries are forced to sell the cottage to cover the taxes.
So how do you pass down the family cottage without the tax burden? Here are a few options.
1. You can save the money your heirs will need to cover the taxes. Using this option you are paying the taxes dollar for dollar. The problem with this option is that often times the savings become taxable as well. Also, if you die before you have saved enough you really haven’t solved the problem.
2. Sell/give the cottage to the kids now. This can be an expensive option. You’re not eliminating the issue, you’re dealing with it now. You still have to pay the taxes dollar for dollar, but you pay them now instead of leaving it to your beneficiaries to deal with when you’re gone. Also many people do not like having to give up control of their cottage. This is something each person needs to decide for themselves.
3. Buy life insurance to cover the taxes. There are types of life insurance that are ideally suited to taking care of estate expenses such as the final tax return. This is the simplest and most efficient way to deal with the problem of making sure your assets, including the cottage, are transferred to your beneficiaries. The death benefit on life insurance is tax-free, which means it is not going to increase the taxes owed, and the cost of insurance is generally only pennies on the dollar.
It’s great to have somewhere to go and enjoy your weekends, relax and unwind while spending time with the family. If this is a lifestyle you want to pass on to your children, grandchildren and many generations to come, you need to take the time to do a little planning now. Speak to one of the professionals at Langlois Financial Services Inc. to see how we can help protect your legacy.