You prepared your will and have specified that the family cottage will be inherited by the children. But keeping the cottage in the family may not be that straightforward. When property is transferred to succeeding generations there are two primary tax issues: the calculation of capital gains and probate costs.

In Alberta anyway probate costs are minimal and therefore not a major concern. When property changes hands other than to the spouse it’s considered a deemed disposition and if a capital gain results a tax liability is triggered. The capital gain is based on the current fair market value (FMV) of the property less the adjusted cost base (ACB). The difference is the capital gain, of which 50% is taxable.

The FMV is usually determined by getting an appraisal by a qualified real estate expert. The ACB is simply the original price paid for the property plus the costs of any capital improvements. This calculation, though, can be difficult if the property has been around for years. Possibly decades of renovations bills are no longer available.

Transfer of the cottage to the next generation could have sufficient financial and emotional impact which (if they don’t have the financial resources to cover the taxes triggered by the capital gains) could result in their having to sell the property. One strategy that can be employed is to set up an insurance policy to fund future capital gains which would pay out at death of the last surviving spouse. The proceeds from the policy’s tax free payout would be then used to cover all or most of the capital gains.

The concerns with this strategy are that based on age and or health, insurance may not be available or be very expensive to fund. Since it’s the children who will benefit from the inheritance of the cottage, the cost of the policy could be borne by them. Also the exact size of the capital gain triggered by the death of the owner is difficult if not impossible to predict. Additional funds may be needed if the insurance is insufficient to pay the final tax bill.

But in the meantime the family can enjoy the property while making periodic contributions, secure in the fact that the property will remain with the family for years to come.

November 3, 2009