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What’s up Dock: Tax Planning for Your Vacation Home
GFX
Jamie Golombek
Managing Director, Tax & Estate Planning
CIBC Wealth Strategies
“The topic of planning for the summer home of a cottage, cabin is an issue that comes up every year because the issue comes down to, who will get the cottage at the end of the day? And ultimately what will the tax complications be, if any, when that cottage or property is passed on? So the first thing we have to keep in mind is who wants the cottage because we can do all the planning that we want, we can set up corporations and trusts and put things in joint names, but at the end the day if we don't have an open discussion with our kids or grandkids as to who really wants the property then we're really wasting our time. So I think the most important thing is, have a discussion and say to the kids, do you want it? Do you want it equally? Or should we maybe equalize the estate if that's our intention by giving, let’s say, Kid A the cottage and Kid B additional cash, securities or life insurance as the case may be.”
GFX
Income tax planning
“Once you've decided that you do ultimately want to pass that cottage down the biggest concern of course will be tax. On death there's a deemed disposition of all your property at fair market value other than property you leave to your surviving spouse or partner. So, the issue of that property really comes down to the second to die. So, if you're married or living in a common law relationship on the second to die there could be a large capital gains tax on the deemed disposition of this vacation property, assuming that's gone up in value. Now generally speaking when you sell your home or on death, your principal residence is tax free because of the Principal Residence Exemption. The problem is you’re only allowed one exemption per couple in Canada. So if you've got a home in the city and you've got a vacation property you really need to decide at the time that you sell one of them which one will be the principal residence and which one will have the tax free gain. So on a second to die, when the spouse has left all the property let's say to the kids, there would be a disposition of everything including the home in the city and the vacation home. And the question then comes down to, which one will be declared as the principal residence and be tax free. And you’d look at a number of things. You’d look at the accrued gain on each one, the period of ownership and then how many years afterwards that's ultimately going to be claimed, and then you decide, you know, which one is going to be tax free and which one is going to be taxable. So the planning that we talk about today with our clients is trying to plan for that ultimate disposition. In other words, are there things that we can do today proactively to try to mitigate some of these tax consequences on death. And of course, the obvious one is just give it away before you die. The problem is that that's a disposition and that's considered to be a gift. And a gift is disposed of at fair market value and therefore, if you just give that property away to your kids today you've sold it. Now again that could allow you to claim the Principal Residence Exemption if it makes sense or if you want to save that exemption for your other home, then you might have to pay some tax.”
GFX
Use of corporations and trusts
“There are other strategies that may involve using a corporation or a trust. Generally people do not use a corporation to hold real estate if it's personal real estate because the CRA deems there to be a fair market value shareholder benefit, but trusts are a viable option. The idea is that you have that vacation property inside the trust. The problem is how do you get it there. Because if you bought it years ago and has accrued gain you can't typically roll it into the trust, its disposition into the trust. So our general advice is, if you're buying a new property maybe you want to consider buying it via a trust. In other words, you take money that you want to buy the property with put it into the trust had the trust buy the property, and therefore upon death, you don't have any kind of disposition. The only concern of course is the 21 year rule. On the 21st anniversary of the trust, then there would be a disposition to the trust, at which point you would roll the property out to the beneficiaries - typically the kids or grandkids of the trust - at the original tax cost. And that is probably the best way in terms of tax planning for the vacation property.”
GFX
Probate fee planning
“One other final consideration is probate. Most provinces, other than Quebec, have a probate tax on death. In Ontario for example, it’s one and a half percent of the value. And the concern ultimately is, that if you don't do some planning either using a joint account, let's say with a spouse or partner, or maybe using other forms of more sophisticated planning like an alter ego trust. The concern is that the subject of that particular probate application will include the value of the real estate. For more information on any of the topics that we've discussed today please see my tax planning bulletin called ‘What's up Dock: Tax and Estate Planning for Your Vacation Home’.”