# Estate Planning - Cottages



## NR05 (Jun 20, 2011)

My family has a cottage which is currently owned by my two grandparents. They're getting older now so the topic of passing the cottage on has come up a lot lately. I've read a lot on the topic of passing on a second property which is not tax exempt like a primary residence and it doesn't seem like there are any great ways to avoid the taxes. I've thought of a potential strategy which could be used to help reduces the taxes and i'm hoping that someone with more tax experience then be can review this and tell me if there are any flaws in there theory.

For illustration purposes lets say the cottage was bought for $100,000 and is now worth $400,000. Meaning there would be a captital gain of $300,000 half of which would be taxed so $150K taxable income.

The strategy would go as follows....Each year over the course of 5 years my grandparents would sell off 20% of the cottage to my parents. This would result in a capital gain of $60,000 half of which would be taxed so $30K taxable income. And because the cottage is jointly owned between my grandparents they could split this and take 15K as taxable each. Since my grandparents are both retired they have minimal income so they could probably get away with paying around 25% tax on this. Which would result in taxes of $7500 each year for 5 Years. which would total $37500. 

If this strategy was not used the cottage would be passed to whichever grandparent lives longer and then when the second grandparent dies they would have a capital gain of 300K which would result in 150K capital gain which would likely be taxed at close to 50% or $75000 all at once. 

Is this strategy feasilble? Are there flaws to my logic?


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## I'm Howard (Oct 13, 2010)

I don't know about selling partial ownership, you either own a piece of property or you don't.

How can you piecemeal a hard asset?


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## Four Pillars (Apr 5, 2009)

Very interesting idea.

You'd probably have to talk to a real estate lawyer or tax accountant (probably better) to get an idea if this is allowed.


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## Plugging Along (Jan 3, 2011)

I don't have any hard proof, but I do not think you can have partial ownership the way you are stating. 

The only way around this, that you can set up a legal trust, with the cottage as a part of it, and then have the parents/kids recieve the trust. There is still tax paid, but you get to control the amount that goes through.

I don't have the details. You definately need a laywer and an accountant to structure this. It is expensive, and there are administration costs. We were told that about $1m in an estate what would start making the fees worth it.


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## NR05 (Jun 20, 2011)

As far as selling pieces the cottage is actually currently owned 80% grandparents and 20% my parents so there must be a way to sell off pieces. My aunt and uncle also owned a portion and my grandparents bought out their share. This leads me to think you are able to sell portions of a property.


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## sags (May 15, 2010)

There would be annual legal and appraisal fees, that would offset tax savings.

If the cottage appreciated year to year, that would also affect the savings.


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## MoneyGal (Apr 24, 2009)

The way to do this is to sell the cottage in a single transaction but report the gains over a maximum of five years using what is known as a capital gains reserve. 

There are some other strategies to reduce the tax hit from transferring ownership of a cottage property within a family, and/or to reduce the tax payable by the selling generation but the specific strategy you are looking for in this post is the capital gains reserve.


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## humble_pie (Jun 7, 2009)

MG this information is so valuable it's sensational.

your next book ? possibly something like How to Micro-Manage your Cottage Taxes (?)

perhaps self-publish as ebook only. A friend in marketing tells me an online author should always write 2 books, one very short & appealing. This book is free to download. It's a marketing tool. Describes the problems. Killer succession taxes when the family cottage is bequeathed to the next generation. Frequent sibling rivalries & jealousies. Hints at variety of smart solutions. Ravishing cottage photographs from sea to shining sea.

2nd book is the real thing. Solid information. Like, who knows what is a capital gains reserve. Here would be the explanation. This is the book that gets sold.

would the same capital gains reserve also apply to parents who own rental or commercial real estate with significant capital appreciation ? i have no clue myself, but if it were the case then such an ebook is almost as essential for many older canadians as pensionizing their nest eggs ...


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## MoneyGal (Apr 24, 2009)

There are lots of books on cottage succession planning; there's no need for another (but IF I write another book it will be on tax issues for sure). 

We used the capital gains reserve in my own family when my mom and her sister sold their cottage to my brother.


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## Plugging Along (Jan 3, 2011)

MG - Great info, I haven't heard of that. Would that apply to rental properties too? Is there a time frame in which one must use the reserves?


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## MoneyGal (Apr 24, 2009)

I honestly did not provide links because Humble says he (I assume Humble is a "he") does not ever click on them (and because CRA's links on this topic are not great). 

The capital gains reserve applies to the sale of ANY property which gives rise to a capital gain, with two exceptions. The basic rules are set out in this link from taxtips.ca:

http://www.taxtips.ca/filing/capgainresother.htm

Note! This is not usually a DIY strategy and professional tax advice is recommended. Ask Young & Ambitious.


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## Square Root (Jan 30, 2010)

Is the capital reserve the result of debt being part of the sales consideration? I seem to recall that being the case. Good advice though.


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## MoneyGal (Apr 24, 2009)

No. A capital gains reserve is purely an accounting and tax mechanism in Canada which allows the seller to take gains into income on a staggered basis. The sale is complete and the deal cannot be revisited; this is only a tax reporting issue for the seller. 

A capital reserve is distinct from a capital gains reserve.


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## Square Root (Jan 30, 2010)

MoneyGal said:


> No. A capital gains reserve is purely an accounting and tax mechanism in Canada which allows the seller to take gains into income on a staggered basis. The sale is complete and the deal cannot be revisited; this is only a tax reporting issue for the seller.
> 
> A capital reserve is distinct from a capital gains reserve.


Thanks.


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## NR05 (Jun 20, 2011)

Thanks MG! I was thinking that I would have to go through the hassle of getting an appraisal each year to do this properly but this makes things a lot easier. 

Would it create any problems if my grandparents were to issue a loan to my parents at 0% interest in order to finance the purchase of the property? ie. each year my grandparents loan my parents 20% of the value of the property which is automatically used to pay for the purchase.


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## Young&Ambitious (Aug 11, 2010)

Here are some sources of information which you may find helpful. Some taxplanning items like Sec85 rollovers just may not worth it when you begin to factor in the costs of doing this.

http://www.taxpage.com/Articles/taxart14.htm
http://www.cra-arc.gc.ca/E/pub/tg/t4037/t4037-e.html#P402_37907

However, it is good you are thinking about this now before the property further appreciates in value. I'm assuming your own tax bracket is higher than your parents-it may make sense for them to pay the capital gain rather than yourself by deferring capital gain taxation. 

The capital gains reserve I believe has a catch...it wouldn't make sense that the CRA would allow someone to pay this gain at their marginal tax rate over 5 years. I don't have my tax books with me at this moment though to check this  

Anyhow please keep us posted and best of luck to you!


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## MoneyGal (Apr 24, 2009)

I'd be interested to hear what you think the "catch" is. 

A capital gains reserve is much less complex than a s.85 rollover and I'm not sure why you would mention rollovers with respect to the inter-family sale of a cottage.


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## MoneyGal (Apr 24, 2009)

NR05 said:


> Would it create any problems if my grandparents were to issue a loan to my parents at 0% interest in order to finance the purchase of the property? ie. each year my grandparents loan my parents 20% of the value of the property which is automatically used to pay for the purchase.


I missed this earlier. There is no problem in principle with your grandparents issuing a loan to your parents at 0%. However there are likely easier ways to structure the sale than what you have outlined. At this point I am going to suggest professional advice.


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## Young&Ambitious (Aug 11, 2010)

I mentioned Sec 85 as that's one commonly used method to defer taxation, just naming an option is all. If it was a cottage that was also being used for rental purposes this idea then may be more attractive. 

The capital gains reserve for this case as it's between non-arms length parties may be seen as a tax avoidance structure...someone specializing in this would know more about the possibility of doing this and structuring it in such a way as to avoid potential difficulties with the CRA :/


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## MoneyGal (Apr 24, 2009)

Young&Ambitious said:


> The capital gains reserve for this case as it's between non-arms length parties may be seen as a tax avoidance structure...someone specializing in this would know more about the possibility of doing this and structuring it in such a way as to avoid potential difficulties with the CRA :/


No. There is no issue, because:

1. The disposition is at FMV. When transactions take place at FMV the non-arm's-length nature of the relationship is not a factor; and 

2. No tax is being avoided. The FULL amount of tax is being paid. However, the gain is being structured to take the gain into income over several years. 

Finally, the capital gains reserve is *not an issue that arises between the parties*. It affects ONE party only and the buyer of the cottage (in this case) is not involved in any way with the decision by the seller to take the gain over several years. As in: this is not a transaction issue. This is simply a tax reporting issue for the seller. Thus, there can be no tax avoidance due to the non-arm's-length relationship of the buying and selling parties because this is not an issue that arises between the parties. 

The use of s.85 would require incorporation. This is a MUCH more complex and costly manoeuvre than a relatively simple capital gains reserve election.


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## Sampson (Apr 3, 2009)

Can I just say that it's fantastic to have such knowledgeable people around!

Thanks Y&T and MGal!


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## I'm Howard (Oct 13, 2010)

The understanding I have is that dual names on a title are for ownership purposes only, that when a piece of Real Estate changes hands, it is a total transfer of R.E.

The other question relates to this deal is, what if the value of the R.E Five Years from now is less, you have locked in a value on which you may pay a higher rate?

I may be wrong, but what if Gramps sold his house, moved in the cottage for six months, then left the whole Pan Abode to the child, would this not be Tax Free??


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## Young&Ambitious (Aug 11, 2010)

Good points MoneyGal - I think I need more coffee yet today haha.

Howard they could designate the cottage as the principal residence but then capital gains would be realized on the parent's principal residence. Which brings up a fantastic point, has the cottage appreciated less than the principal residence??


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## andrewf (Mar 1, 2010)

I'm Howard said:


> The understanding I have is that dual names on a title are for ownership purposes only, that when a piece of Real Estate changes hands, it is a total transfer of R.E.
> 
> The other question relates to this deal is, what if the value of the R.E Five Years from now is less, you have locked in a value on which you may pay a higher rate?
> 
> I may be wrong, but what if Gramps sold his house, moved in the cottage for six months, then left the whole Pan Abode to the child, would this not be Tax Free??


I think if cottage becomes the PR, tax must be paid on the assessed value at time the use changed.


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## NR05 (Jun 20, 2011)

Thanks again MoneyGal. And yes if my family decided to go down this road there is no question that we would involve a professional. And to answer the questions about using the cottage as a principal residence. It wouldn't work out any better for us as my grandparents house has appreciated roughly the same amount. I'm also not sure if this would work as i think it would trigger a capital gain when you made this change but i could be wrong there.


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## Sustainable PF (Nov 5, 2010)

I wrote a guest post @ Million Dollar Journey on the topic as a whole:

Children and Capital Gain in Cottage Country

I'm pretty sure that you can't split like initially suggested.

Some options for you include:

- what Money Gal said
- see if it makes sense for your grandparents to claim the cottage as their principal residence (will there be a high CG on their current residence? Do they happen to live in a home, or an apartment?)
- look in Alter Ego Trusts. Complex yes - consult a lawyer - but this could cost a lot less than paying the CG
- do your grandparents have life insurance that may cover the CG tax?

Just some ideas - check out the article @ FTs site.


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## Charlie (May 20, 2011)

Just to clarify...Square Root was correct in that debt must be present for the Capital Gains Reserve. You cannot arbitrarily choose to defer a gain over 5 yrs. (It would be great if you could -- work wonders for income smoothing -- but no such luck).

But as outlined in Sustainable PF's article...this debt can be at 0% and can be forgiven either through the will, or over time. 

The max reserve is the % of proceeds outstanding x the gain, with a min of 20% coming into income each yr. So it's important to register the mortgage (easy to do), and to not forgive more then 20% per yr until the 5 yrs are up.


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## MoneyGal (Apr 24, 2009)

Here is the circular from CRA:

http://www.cra-arc.gc.ca/E/pub/tg/t4037/t4037-e.html#P402_37907

And here is the CRA form:

http://www.cra-arc.gc.ca/E/pbg/tf/t2017/t2017-10e.pdf

Charlie, you and I may be talking past each other. But I'd be interested in your explanation of how "debt must be present." I'm not sure what you mean. You may mean that the child is paying the parent (in this example) over time. 

I just went back and reviewed the post from SR and I was assuming he was referring to an actual capital reserve, not a capital gains reserve; and that debt needed to be present prior to the transaction taking place (i.e., a capital reserve to fund a future obligation), which is not the case with a capital gains reserve.


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## Charlie (May 20, 2011)

in your first link the paragraph on Claiming a Reserve is as follows:



> When you sell a capital property, you usually receive full payment at that time. However, sometimes you receive the amount over a number of years. ...If this happens, you may be able to claim a reserve.


On the form, the top bit of the fraction on page 2 (i) is "amount payable after end of year" That's the debt. If it's zero, the 'lesser of' calculation for the max reserve is also zero -- so no reserve...


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## Charlie (May 20, 2011)

...and, yes, the debt can be child to parent. But it needs to exist.


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## MoneyGal (Apr 24, 2009)

OK. As I said, I read SR's original post as a capital reserve question. We are saying the same thing.


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