Do your children want the property?
The first thing to consider is whether your children or grandchildren are interested in owning the property. Although they may enjoy spending time there with you, there’s no guarantee that they will be interested in maintaining or using the property after you’re gone; particularly if they live in another province. If you have more than one child, you will also need to determine if they are interested in sharing ownership and responsibility for the property with their siblings.
Once you’ve confirmed that your children are interested in owning the property, it’s important to think about the tax liability that inheritance will trigger for them and make plans to help mitigate the impact.
When a vacation property passes to anyone besides your spouse or common-law partner at the time of your death, it will trigger a tax liability for your estate based the appreciation in the value of the property. That appreciation is calculated using the fair market value of the property at the time of transfer, less the purchase price and the cost of any improvements made to the property during your period of ownership. As your vacation property may have increased considerably in value over the years, the concern is that the tax liability could be so large that your beneficiaries may have to sell assets—possibly the vacation property itself—to meet the tax obligation. Making provisions for the transfer of your vacation property as part of your estate plan is, therefore, essential.
Strategies for mitigating the tax impact
1. Using the principal residence exemption
One possible way to reduce the tax liability is to designate the property as your principal residence to exempt some or all of the capital gains on its disposition from taxation. Keep in mind that your family can only have one principal residence in a given year, but you don’t have to designate which property that is until you sell it or are deemed to have disposed of it (as you would in the year of your death). Your executor or liquidator should consult with your tax and financial advisors to determine how to use the principal residence exemption to best advantage.
2. Preserve the adjusted cost base
The taxable capital gain on your vacation property can be reduced by increasing the adjusted cost base (ACB) of the property. The ACB is increased by adding the costs of property improvements made over the years to the initial purchase price. So, be sure to keep records and receipts for materials and professional fees paid for renovations and upgrades.
3. Using insurance
If your estate doesn’t have sufficient liquid assets to cover the capital gains tax that will be triggered by the transfer of your vacation property, consider using life insurance to cover the liability. Your children may even be willing to pay the premiums on a life policy if it means being able to keep the property without having to cover a large tax bill down the road.
4. Gifting during your lifetime
As is the case with a transfer of a vacation property upon death, gifting a property during your lifetime will be deemed to have occurred at fair market value (unless you transfer the property to your spouse). This means you will be liable for tax on the capital gain calculated as the difference between what you paid for your vacation property and what it’s worth now. If you choose to sell a property to your children during your lifetime for less than its fair market value, you will, regardless of the selling price, be deemed to have received fair market value and will be responsible for the tax on difference.
Although capital gains taxes on the disposition of a vacation property cannot be avoided by gifting it during your lifetime, one potential advantage of this strategy is limiting the amount of tax payable by gifting the property at its current market value, rather than its potentially higher value at the time of your death.
If one or two of your children want the vacation property, but others do not, the issue may become how to equalize the estate, and you may want to consider using insurance to help fill the gap.
If several children want the property, then you should also consider having a co-ownership agreement between them created before the property is transferred (and possibly as a condition of inheritance). Such an agreement outlines how the property will be used, who is responsible for its upkeep, and how the property will be passed on in the future.
U.S. and foreign properties
There are different and significant tax implications pertaining to the succession of vacation properties outside of Canada. When considering purchasing or passing on such properties, it is important to speak with a cross-border tax advisor.
As you can see, it’s important to plan for how a vacation property will be passed on to the next generation long before it happens. For more information, speak with your IG Consultant and ask them for copies of our white papers, Vacation Property Succession Planning and Canadians Owning Vacation Properties in the U.S.
Written and published by IG Wealth Management as a general source of information only, believed to be accurate as of the date of publishing. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Trademarks, including IG Wealth Management and IG Private Wealth Management are owned by IGM Financial Inc. and licensed to its subsidiary corporations. Insurance products and services distributed through I.G. Insurance Services Inc. (in Québec, a Financial Services Firm). Insurance license sponsored by The Canada Life Assurance Company (outside of Québec).