Across Canada, there are families with vacation property that has significantly increased in value since its purchase. You believe you’re sitting on a gold mine – until you leave the property to your children or grandchildren. Thanks to the capital gains tax, they may inherit something that brings stress rather than rest.
What is capital gains tax? Let’s say, as a vacation property owner, you plan to transfer ownership of the property to your children through a will. You bought the property for $80,000 and today it’s worth $240,000. When the will is carried out, it’s estimated that the property will have doubled in value to $480,000 for a capital gain of $400,000. Using a marginal tax rate of 45%, the capital gains tax – payable on 50% of the gain – is $90,000. To pay the tax, some heirs choose to sell the vacation property.
The most common strategies to minimize tax
Fortunately, there are ways to minimize the tax liability, the following being among the most common.
Use the principal residence exemption. Does your vacation property have a higher capital gain than your home? You may be able to designate the vacation property as your principal residence, which is exempt from capital gains tax. Your home would then be subject to tax on capital gains. But contact a tax professional – you must ensure you’re onside with Canada Revenue Agency (CRA).
Gift the property to your children now. If you give the property to your children now, the transfer triggers a taxable capital gain in the year of the gift, limiting the tax hit to its current amount. Future appreciation rests with your children, and it could be many years before they sell or transfer the property and capital gains tax becomes payable.
You can also transfer ownership — whether by gifting or selling — over a period of several years, say 20% of the property’s value annually for five years. Spreading out the tax makes the payments to CRA more manageable.
Establish a family trust. Another way to trigger the capital gain now is to hold the property in a family trust with your children as beneficiaries — especially useful if you want some control over the property’s ownership and management after your death. In a trust, the capital gains become payable every 21 years, so you must plan for that eventuality.
Purchase life insurance. A common strategy is to purchase life insurance on your life and name your children as beneficiaries. You choose a face amount estimated to be equal to the tax on capital gains, and your heirs apply the tax-free insurance proceeds to offset the tax liability.
Talk to your advisor if you own a cottage, cabin, chalet, or other property. They can explore the costs and benefits of various strategies and help you choose the most suitable approach.