LOVE THE COTTAGE?
Will it be able to stay in the family, or will it have to be sold to pay the income tax liability?
You may feel that because you managed to inherit the family cottage from your parents that passing it down to your children will not be an issue. Well it may not be, if it is structured correctly an done legally. However for many people it is not as simple as it use to be. Capital Gains taxes, the Family Law Act, The 4 D's, (Death, Divorce, Disability & Disagreement) can all interfere with your plans in a smooth transfer of ownership from one generation to another.
Some people are not concerned about the loss of control, loss of wealth or the loss of use of family assets that occur after their death. Occasionally, there are no living relatives or close friends, so estate planning is not a big concern. Or, some people choose to use the estate planning technique known as "die broke" and leave nothing behind.
If you don't mind the government benefiting from all your hard work, you likely do not need a plan to transfer your assets to your loved ones or your favorite charity. However if you would rather see your favorite charity, your children, or your friends and relatives benefit from your hard work then you need a plan and you need it in place long before anything happens.
Many people are concerned that without proper planning, there may be family disputes after their death. This concern is very well founded. Arguments and disagreements over the settling of an estate can have long-lasting repercussions on family members. This is particularly true if some of the children have developed an attachment to certain assets, such as the family cottage, which they may end up being forced to sell, if it has a large deferred capital gain on it.
Be aware that Capital gains tax on your cottage is not the only problem. You may also have a deferred tax liability on your registered assets (e.g. RRSPs/RRIFs). Upon your death 100% of the value of these assets could be subject to taxation.
When you die, the total value of your RRSPs and RRIFs (if not left to a spouse or dependant minor child) are included in your income for that year. This means almost half of the value of your registered plans could be payable to CRA upon death.
Unfortunately, many people are unaware of the consequences of their deferred tax liabilities, and fail to examine options for preserving their estate.
(Please note that estate planning is a very personal and complex issue and the items discussed below are just some of the possible solutions. Please contact me at wegreen@feeonlyplanner.ca to determine what is best for you and your unique situation)
When it comes to estate planning: money changes everything, remember how the kids use to fight over that piece of cake when they where young?
Use this chart to compare the various, risks, benefits and results of each estate planning option
| Option | Risks | Benefits | Result |
| Do nothing | A larger than necessary tax bill | No current, or ongoing costs | Ignores the issue and defers the liability |
| A greater total cost to your estate than necessary | You maintain control | ||
| Transfer to the kids | A current tax bill | No further liability to your estate | Pays the current tax and transfers the future liability to someone else |
| Loss of control | |||
| Could be subject to creditor risk | |||
| Could be considered net family property in the event of divorce or separation | |||
| Loss of use of capital if needed | |||
| Your children or grandchildren could face an even bigger liability | |||
| You no longer own the asset | |||
| Can not be used for registered assets (RRSP/RRIFs) | |||
| Transfer to a personal corporation | Possibly a greater future tax bill than necessary if asset declines in value | You can freeze the current tax bill | Pays the current tax and transfers the future liability to someone else |
| Personal use tax rules may apply | |||
| Possible current tax bill | |||
| Current set up costs | |||
| You can maintain limited control | |||
| Annual maintenance costs | |||
| Annual tax returns must be filed | |||
| Can not be used for registered assets (RRSP/RRIFs) | |||
| Estate preservation plan | You may not qualify if you are uninsurable. The sooner an estate plan is put in place the easier it is to qualify for. However it is never to late to apply. Don't assume that you are uninsurable, find out. | You maintain control of your assets and the policy | Creates a tax free source of funding and defers liability as long as possible |
| May reduce current and future taxes as investments inside of the policy grow on a tax sheltered basis if set up and maintained properly and are paid out as a "Tax Free" benefit to the estate | |||
| A guaranteed source of funding the "Success Tax" | |||
| Tax and Probate free benefit | |||
| Can be a source of extra income if needed before death | |||
| Guaranteed known cost | |||
| Can be paid for with a single payment or ongoing payments | |||
| May not reduce the future tax bill, it just creates a discounted source of funding the liability | Investment required is often less than the current "Success Tax" due | ||
| The kids can pay for it or help pay for it | |||
| Can greatly increase the value of the estate | |||
| Cash value can be accessed at any time | |||
| Costs just pennies on the dollar | |||
| May be protected from creditors | |||
| Can be set up to keep pace with inflation | |||
| A complete solution for all of your "Success Tax" items | |||
| Can be used to shelter current investments and investment income to reduce current taxes | |||
| Option | Risks | Benefits | Result |
F.A.Q.
Q: Can I just sell the cottage to my Children for a nominal sum, such as $1?
A: Yes you can; however that creates at least four problems:
1) You can sell an asset for any price you wish. However you are deemed by Revenue Canada to have sold the asset at it's current fair market value ( FMV), so you still have to pay the tax due as if you sold it for it full value.
2) Your child is now faced with double taxation as their adjusted cost base (ACB) for the property is now $1, which means that they legally have to pay tax on the amount you have already paid tax on.
3) It subjects the cottage to the 4 D's and puts the asset at risk.
4) You are no longer in control, so if it turns out that later on you need the cash from the cottage to fund your retirement, you are at the mercy of the new owners, who may of may not be willing to help you out.
Q: Can't we just add the children’s names to the title so that when we pass away the cottage ownership passes to them and avoids probate?
A: While this does avoid probate, it does not deal with the capital gains issue and your estate is still faced with the income tax bill on the capital gain. Probate is generally not a big issue when it comes to cottage succession as the maximum probate fee in Ontario is 1.5%. While the Capital gains taxes could be as high as 25% of the value of the cottage.