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All across Canada, families own vacation property that has significantly increased in value since its purchase. You think you’re sitting on a goldmine – until you leave the property to your children or grandchildren. Thanks to tax on capital gains, they may inherit a tax nightmare.
Let’s say a vacation property owner plans to transfer ownership of the property to his children through a will. The owner bought the property for $80,000 and today it’s worth $240,000. It’s estimated that when the will is carried out, the property will have doubled in value to $480,000 for a capital gain of $400,000. Using a marginal tax rate of 45%, the capital gains tax – payable on 50% of the gain – is $90,000 . Some heirs have been known to sell the vacation property to pay the tax.
Fortunately, there are numerous ways to minimize the impact of the tax liability, the following being among the most common.
Using the principal residence exemption. Does your vacation property have a higher capital gain than your home? You may be able to designate the vacation property as your principal residence, which is exempt from capital gains tax. Your home would then be subject to tax on capital gains. But contact a tax professional – you must ensure you’re onside with Canada Revenue Agency (CRA).
Gifting the property to children now. If you give the property to your children, the transfer triggers a taxable capital gain in the year of the gift, but you limit the tax hit to its current amount. Future appreciation rests with your children, and it could be many years before they sell or transfer the property and capital gains tax becomes payable.
You can also transfer ownership — whether by gifting or selling — over a period of several years, say 20% of the property’s value annually for five years. Spreading out the tax makes the payments to CRA more manageable.
Establishing a family trust. Another way to trigger the capital gain now is to hold the property in a family trust with your children as beneficiaries — especially useful if you want some control over the property’s ownership and management after your death. In a trust, the capital gains become payable every 21 years, so you must plan for that eventuality.
Purchasing life insurance. A common strategy is to purchase life insurance on your life and name your children as beneficiaries. You choose a face amount estimated to be equal to the tax on capital gains, and your heirs apply the tax-free insurance proceeds to offset the tax liability.
Talk to us if you own a cottage, cabin, chalet, or other property. We’ll tell you about the costs and benefits of these methods and let you know about related strategies.