Managing Your Money

After a long, cold winter, summer is finally here! For those of you who escape to the peace and relaxation of cottage life during the summer, your plans are surely in full gear. You can already smell the fire and hear the sounds of country living. Maybe it’s been a tradition since childhood, a family cottage where many memories have been created. It may also be a place that requires financial investment and upkeep, and this is sometimes where the challenges begin.

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At some point family cottages change hands and get passed down to the next generation. The tax hit in these cases can sometimes be heartbreaking to those who have always seen the cottage as a stress-free environment. Being prepared and using the right strategies can usually minimize the surprises and reduce the financial costs. Here are some things to consider:

  1. Estate planning: First, decide who gets it, and assess the financial considerations around that decision. I would argue that it is wiser to establish the future of the cottage sooner rather than later. If there are multiple children who agree to share it and get along doing so, that’s great – but often that’s not the case. When one sibling uses it and looks after it and the others don’t, then some decisions should be made for the benefit of all involved.

I had a situation recently where Mom and Dad bought a cottage many moons ago for pennies. Mom is now in her 90s, lives in a seniors residence, and no longer uses the cottage. The use and upkeep has fallen on one brother who lives in Montréal. The other brother lives on the West Coast and rarely gets into town to enjoy it. Since the cottage is quite old, the local brother has put a great deal of work into its maintenance, doing repairs and renovations with the financial costs directly out of his pocket. In this case the situation is simple and straight forward. The West Coast brother does not want ownership of the cottage and acknowledges that the Montréal brother has put a significant amount of money into the cottage already. Mom and sons have all agreed that the Montréal brother should inherit the cottage leaving the balance assets to be divided equally.

  1. Principal Residence Exemption: This is one of the most important tax breaks for Canadians. It allows you to reduce or eliminate capital gains tax when you sell your home or cottage. Presently, only one principal residence can be designated per family. For the years before 1982, each spouse could designate a principal residence. So, if a cottage has been in the family many years, a husband can designate the cottage as his principal residence for years up to 1982, while the wife designates the family home as her principal residence, thereby eliminating capital gains tax on both properties up to that point. In the example I gave above, even though Mom, the owner of the cottage, is not using it, it can still be considered a principal residence because her son is currently using it.
  2. Choosing a principal residence: Since the beginning of 1982, a family had to make a choice as to which property they would designate as their principal residence. As long as the cottage is being used, even occasionally during the year, and the main reason for owning it is not to produce income, the cottage could be designated as the principal residence, even if there is a family home which is the main living space. Choosing which one to designate as the principal residence at the time of sale requires a careful consideration of the increase of value of each property. Simply put, whichever property has the biggest increase in value would be the one you would want to designate as the principal residence, thereby avoiding capital gains tax on that property. You can also choose to designate a property for a portion of the years that you owned it. For example, if you own both a home and a cottage for 20 years, you could designate the home as your principal residence for 13 of those years and the cottage as your principal residence for 7 years. Again, always considering where and when the biggest increase in value occurred.
  3. 1994 capital gains exemption: Up until 1994, the government allowed everyone to earn $100,000 of capital gains without being taxed on it. In 1994 that rule was eliminated but everyone had a chance to shelter their existing gains (max $100,000) up to that point. It required making an election on your tax return to do so. So, check with your tax preparer or CRA to see if you made that election on your cottage back in 1994.
  4. Capital gains reserve: This allows you to spread the capital gain over a period of up to five years. You’ll still pay tax on the full capital gain, but you will keep the money in your pocket longer. And by spreading it over five years you may lessen the overall impact of the capital gain by not claiming it all in one year thereby pushing you up into a higher tax bracket. This strategy will obviously have less of an impact if you’re already in the highest tax bracket. Assuming the cottage is being transferred to your children, money doesn’t have to actually change hands, but it does have to be transferred at fair market value. Speak to your accountant about structuring the sale of the cottage properly if you decide to use this strategy.
  5. Trusts: Many families consider using a formal trust structure to hold a family cottage. This can establish specific terms clarifying the funding and future use of the cottage by family members. This can be a great way to prevent family squabbling, but there are complexities involved with using a trust for a cottage that can create traps for unknowing beneficiaries. Consult your tax and legal advisors to determine if a trust fits for your family situation.

Keeping a cottage in the family can create great memories for generations to come.  When it comes time to pass on the cottage, or make decisions about passing it on, consider the available strategies and make the right decisions so that the whole cottage experience remains a place of relaxation, and not a financial stress. Getting the right tax and legal advisors involved can help make the whole process smooth and worry-free.

Lynn MacNeil, F.PL. Vice President, Investment Advisor, is a Financial Planner with Richardson GMP Limited in Montreal, with over 22 years of experience working with retirees and pre-retirees. For a private financial consultation, or more information on this topic or on any other investment or financial matter, please contact Lynn MacNeil at 514.981.5795 or [email protected].

The opinions expressed in this article are the opinions of Lynn MacNeil and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances. Richardson GMP Limited, Member Canadian Investor Protection Fund.

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