How to minimize capital gains on cottages
The challenge of what to do with the family cottage will be one decision many families will find ‘taxing’! Cottages hold many memories and ‘Life worth’ beyond their net worth.
If you want to keep the cottage in the family, the more common approaches include giving the cottage to your kids, selling the cottage to one of more children, joint ownership with your kids, willing the cottage to your kids or putting the cottage in a trust. There is no way to avoid paying the capital gains tax on the growth in value of the cottage, but there are ways to minimize it. Creating a plan now to transfer the cottage could minimize future taxes by thousands of dollars.
The first thing to do is to ensure you have a valid cost base for the cottage; what the cottage was valued at when you acquired it plus every dollar you spent on improving and maintaining the cottage property. Remember to keep all receipts and invoices! All these dollars add to the cost base of the cottage and reduces the tax to be paid on the capital gain.
The next thing is to understand what the potential tax will be on the cottage. The amount to be included as taxable income is 50% of the fair market value less the cost base of the cottage. At death, tax is usually paid at the highest marginal tax rate so the tax owing will be about 23% of the capital gain on the cottage.
One often overlooked technique is to declare the cottage the principle residence for all or some of a period of time
There are disadvantages to leaving the cottage to family in a will. The estate usually pays tax at the highest rate and less planning to reduce or differ tax is possible.
One way to handle transferring the cottage to beneficiaries now is to simply sell it to them. If they don’t have the cash take back a demand loan which can be forgiven in the will. Taking back a demand loan means you are not receiving all the proceeds from the capital asset immediately and you can spread the capital gains tax over a maximum of five years.
Any capital losses can immediately be used to offset capital gains, purchasing a flow through share investment may also be an option as it would convert some of the tax you would pay into an investment.
The transfer of the cottage could also be planned when income will be lower which would minimize tax owing.
There are many aspects to the above strategy that were not mentioned and each situation has its own challenges. A good accountant, tax lawyer or financial planner can help you with an estate planning strategy that works for you.