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Cottage Insurance – How to Take Care of the Tax Liability When Transferring it to Your Children

| June 23, 2015 | 3 Comments

Keeping the cottage in the family

With the school year almost over and the long cold winter finally over (knock on wood), most of us our planning what to do this summer with the family. For some of you that means spending time enjoying the family cottage – campfires, swimming and mosquitoes. But what about future summers? When it comes time to transfer the cottage from your parents to you or from you to your children who is going to pay the tax bill? 

When you and your spouse, Canada Revenue Agency (CRA) considers it as if you sold the cottage at its current market value.  The difference between your original cost and its current value (called ‘capital gains’) gets taxed.  The tax rate on capital gains is 50% in Ontario, so a cottage bought for $100,000 and now worth $500,000 will see CRA owed approximately $92, 820 of taxes on deemed disposition.

Capital gain x 50.00% x marginal tax rate = capital gain tax

= $400,000 x 50.00% x 46.41%

= $200,000 x 46.40%

= $92,820

That is what the tax bill looks like if both passed away today, here is what it would look like 20 years from now taking inflation at 3% – $180,246. How can you or your children pay for a hefty tax bill like that to keep the family cottage in the family?

Here are three options you can consider:

  1. Do nothing.
  2. Sell to Children
  3. Life Insurance

Do Nothing

This is the simplest and easiest option, doing absolutely nothing about it. Save it as a big surprise for your children and family, because nothing says I love you like getting a big bill from CRA after your gone. When the time comes, your family or children will have to either sell it or borrow money to pay for taxes. I don’t recommend this option and most people I talk to don’t take it, they would rather have all loose ends tied up and have a smooth transition of the property for future generations to enjoy.

Sell to Children

I want to clarify it says sell to children, not sell the children, I don’t want get a bunch of angry e-mails from parents saying how dare I suggest an option.  You could sell the cottage now while taking back a life interest, and ensuring you will have guaranteed use of the cottage for the rest of your lives. Gifts of real property to family members have no land transfer tax. Under the Income Tax Act, such a transfer will trigger a deemed disposition at fair market value. The tax liability becomes immediately payable by the parents and the value of the cottage is effectively “frozen” until  the children decide to sell off their interests in it.

In this case I’m using  the tax bill  will be considerably lower than $180,246 20 years from now with inflation. The total tax liability at death may be substantially greater and the deemed disposition at death of the cottage will get pooled with all other date-of-death income, thereby missing the opportunity to pay less today, especially since the cottage will undoubtedly be worth more in the future.

Capital gain x 50.00% x marginal tax rate = capital gain tax

= $400,000 x 50.00% x 46.41%

= $200,000 x 46.40%

= $92,820

If  it makes sense to transfer the cottage to the children today, you will need to consider the following:

How do you arrange payment of the capital gains tax liability?

How do you protect your right to continued use of the cottage? 

How do you protect the family and the cottage from creditors or disgruntled ex-spouses?

Life Insurance

Life insurance is often the most cost-effective planning tool to cover the tax liability at death. Although you could start a plan to save the funds needed to pay the tax, you cannot predict when the tax will become payable. A permanent life insurance policy will not only provide the capital when needed, over your lifetime it is the most cost-effective solution.

– Life insurance allows you to custom design a solution to meet your specific needs.
– It creates immediate estate liquidity to pay for the tax.
– You can choose a death benefit that increases over time to match the growing tax liability.
– You can customize the amount and number of deposits you make into the plan to suit your needs.
– Certain insurance products offer a broad range of investment accounts, if you choose to invest money in
   your policy over and above the cost of the insurance it provides.
– Your advisor can use the expertise of tax and estate planning professionals to help with complex situations.

Example:

Capital gain x 50.00% x marginal tax rate = capital gain tax

= $400,000 x 50.00% x 46.41%

= $200,000 x 46.40%

= $92,820 

20 years from now at 3% inflation = $180,246

T100 Life Insurance policy for male 65 with $181,000 death benefit = $5684 a year 

If at anytime in the next 20 years the owner of the cottage passes away the tax liability will be covered with a tax free death benefit payed to the beneficiaries. If they pass away 20 years from now the tax liability on the cottage will have cost them $113,680 which is a savings of $66,584.

To find out which strategy is the financially efficient for you situation, please contact me and using my software I can show you which option makes the most sense for you. With the proper planning you can make the passing down of the cottage to your children smoothly and the most cost effectively.

For information purposes only and not intended to provide specific advice. Readers are advised to seek professional advice before making any financial decision based on any of the ideas presented in this article.  The author does not guarantee the accuracy and will not be held liable in any way for any error, or omission, or any financial decision.

Andrew  @AndrewWBradley

 

Photo credit: mathewingram / Foter / CC BY Photo credit: mathewingram/ Foter / CC BY

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Category: Finance, Living, Tips, Weekly Themes

About the Author ()

Andrew is a licensed Life Insurance Broker and Registered Retirement Consultant-RRC® helping Ottawa families since 2011. He is a father of two boys, owner of LifeInsurance-Orleans.ca, LifeInsurance-Ottawa.ca and was a host of Ottawa Experts on Rogers Cable 22. Author's website.

Comments (3)

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  1. Elizabeth Matthiesen says:

    Not only can life be complicated but death too. I really don’t understand why the tax people get such a huge share, that just doesn’t seem fair. I’m glad that I don’t have a cottage to pass down the line when I go!

  2. heidi c. says:

    We hope someday to have a cottage. When and if we do buy one, I am going to make sure that we are up on all the legal and tax issues.

  3. Victoria Ess says:

    This will be useful for us in the future! Thanks for sharing!

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