Cottages remain sound investments if…you are aware and have planned for some of the more complicated factors
In the years since those early pandemic months, Canadian cottage markets have largely returned to normalcy. Unlike the residential housing market, which remains buoyed by imperatives like population growth and has therefore only experienced modest corrections, fewer complicating factors govern Canada’s cottage markets.
But while that once again makes cottages, as an asset class, a shrewd addition to one’s portfolio, these purchases aren’t for the uninitiated because cottages are infamous for their confusing tax structures.
A look into the ‘in’s and outs’ of the unique tax considerations and estate planning challenges
Cottages are considered capital assets, so if they are not designated as your principal residence (principal residence are exempt from capital gains) and passed down to a family member, there will be tax implications. If left to an heir in a will, the cottage will be deemed to have been sold at fair market value and any increase in value, minus the cost of improvements, will be considered capital gains and taxed at the deceased’s marginal tax rate. This could trigger a $100,000 to $200,000 tax bill, which in the worst-case scenario could require the beneficiary to sell the property in order to pay it off.
Some Strategies for Dealing with the Tax and Estate Issues
One way to prepare for such a capital gains bill is through a family-funded life insurance strategy. As mentioned, it is also important to track all expenses that go towards improving the cottage, as they could provide a little additional tax relief.
Rather than leaving it to your heirs in a will there is also the option of creating a trust that owns the cottage. This is deemed a disposition by the Canada Revenue Agency but it’s a strategy that could help avoid legal issues in the future. Moreover, the parents can still control the cottage and name their children as beneficiaries. It would also avoid probate issues later on.
Trusts require separate tax returns, which can be somewhat confusing, but by having a deed of gift, because cottages are often the subject of intense litigation between family members, courts put them through estates. Moreover, trusts are also needed to satisfy questions pertaining to who has rights to the cottage, as well as when, and who is responsible for maintenance or further development. Trusts can also dictate whether sale to a third party is permitted. In short, trusts ultimately preclude internal family squabbles over the cottage.
Another option is to sell up and give the proceeds to the kids, letting them decide what to do with the money. This is the unsentimental option, but it may be the best way forward for your family, removing future complications or potential conflicts.
A shadow looming over the capital gains issue is the upcoming changes, which are set to take effect on June 25, 2024. For those whose cottage has skyrocketed in value it pays to be aware that the inclusion rate will increase to 66.7% for those realizing more than $250,000 in annual capital gains. Gains below this threshold remains at 50%.
Check out part three of this series, where we look at some important factors to be mindful of - Such as the impacts that location and timing can have on your investment.
