Sara and John S., both 65 years old, met with me recently to discuss how to transfer ownership of the family cottage to their three children. They have two concerns: The value of the cottage has appreciated considerably since they bought it 15 years ago and approximately 50% of the increased value will be subject to capital gains tax. Second, their children are married with young children and big mortgages, and thus may not have extra cash to pay the potential taxes owing at the time of their passing.
A. Sara and John aren’t sure where the cash will come from to pay the tax liability. They will not have other estate assets that can be liquidated and they are fearful that the tax liability, plus probate and transfer fees may necessitate the sale of the cottage.
One approach is for Sara and John to retire to the cottage and, following the sale of their city home, use the cottage as their principal residence. In this way, they can take advantage of the capital gains exemption on principal residences. This may not be practical due to health and family considerations in their later years.
Another option is to estimate the taxes owing at death and to save the money. A more tax effective strategy is to purchase life insurance to cover the estimated tax liability. For example, Sara and John would pay less than $1,500 a year to buy $100,000 of life insurance. If they were to save the equivalent amount over the next 20 years in a taxable account, they would need to earn 10% a year on that investment in order to save the $100,000.
Alternatively, they could sell or gift the cottage to their children and cap their tax liability now. Future growth in the cottage’s value is now taxable in the hands of their children when they either dispose of it or transfer ownership to their children. This strategy avoids probate as the transfer happens now, outside of Sara and John’s estate. However, it will trigger an immediate taxable capital gain in the current year and control of the cottage is now relinquished to the new owners, their three children. The Canada Revenue Agency (CRA) will calculate the capital gain based on the cottage’s current market value, regardless if the cottage has been gifted or sold at nominal value. Furthermore, when the children pass on the cottage to the next generation, CRA will calculate their capital gain based on the nominal price paid.
The Result:
It’s important to seek professional advice because there is no ‘one-size-fits-all’ answer. In Sara and John’s case, maintaining ownership of the cottage was important to them. As they are in good health, they chose to purchase life insurance to provide the liquidity to ensure that sufficient funds would be available to their children when needed.
Bev Moir is a financial planner with The Moir Team at ScotiaMcLeod in Toronto. ScotiaMcLeod is a division of Scotia Capital Inc., a member of the Scotiabank Group. Member CIPF.
This article is for information purposes only. It is recommended that individuals consult with a financial or tax advisor before acting on any information contained in this article. The opinions stated are not necessarily those of Scotia Capital or The Bank of Nova Scotia.
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