Many Canadians families either currently own or are considering the purchase of a cottage property. Normally they would simply pay for the cottage and register the title in the purchasers’ individual names. In many areas, due to limited supply of waterfront property and increasing demand cottage properties can have significant increases in value over a number of years.
When the original purchasers pass away or want to transfer or gift the property to the next generation there is a significant capital gain on the transaction. In Canada, the capital gain also means a significant cheque payable to the Receiver General to pay the taxes on the disposition.
A flexible alternative to holding the cottage property title may be a Family Trust.
What is a Family Trust?
A trust can be a useful estate planning tool for cottage owners. There are three parties required to form a Family Trust: the settlor, trustee and beneficiary. The trust is created when the settlor transfers certain assets (i.e. the cottage property) to one or more trustees, who hold and manage those assets for the benefit of the beneficiaries (i.e. children, grandchildren and other family members). The beneficiaries enjoy the use of the assets but do not legally own them. If, for example, you transferred your cottage to your brother to be held “in trust” for your children and grandchildren, your brother would legally own the property, but your children – not your sister –would be entitled to use the property.
A trust set up during the lifetime of the settlor is called an “inter-vivos” trust (generally this iswhat a Family Trust is), while a trust set up upon the death of the settlor through his or her will is a “testamentary” trust. Currently, inter-vivos trusts are taxed at the highest marginal tax rate while testamentary trusts are subject to graduated rates of tax, like individuals (although the 2013 federal budget is considering a change that could see testamentary trusts have this tax benefits everely curtailed or eliminated).
What are the Benefits?
Holding your family cottage in a trust can provide some benefits, including: protection from creditors (assets held in certain trusts can be difficult for creditors to reach), protection from thecottage in a divorce situation, proper governance (in larger families having only one or twotrustees manage the property can minimize disputes), tax minimization as future growth in value does not accrue to any one individual (which can reduce or defer taxes), maintaining control of the cottage (the settlor can be named one of the trustees, who manage the property), and minimizing probate fees (as the cottage does not form part on the settlor or trustees estate if they should pass away).
The Decision to Use a Trust:
In deciding whether to set up a trust to hold your cottage, there are a few potential issues to consider:
- There is a deemed disposition every 21 years from the creation date of the Trust. On the 21st anniversary of the trust there will be a deemed disposition of its assets at Fair Market Value, which could trigger taxable capital gains (and income taxes payable) at that time. There are ways to deal with this potential tax hit, including distribution of assets of the trust to beneficiaries before that date (if done properly this can be done at tax cost and defer any capital gain), or the trust’s use of the principal residence exemption on the property, among other ideas. You should work with your tax professional on this type of planning.
- The principal residence exemption can become complicated to utilize as a strategy. A trust can use it to shelter a sale of the cottage from tax as long as one or more of the beneficiaries stay at the cottage regularly each year. However, it may make more sense to distribute the cottage to one or all of the beneficiaries before the property is sold. If the trust designates the cottage as a principal residence for a given year then this can impact the beneficiaries’ ability to also designate their own homes as a principal residence for the same time period.
- Transferring assets to a trust can be a taxable event. In the case of a vacation property, it simplifies things if you set up a trust to acquire it from the outset. If you already own the cottage and it has increased in value, transferring it to a trust can trigger a capital gain and tax that will need to be paid. As mentioned above, it may be possible to shelter this gain with the principal residence exemption, but whether this is possible, or sensible, will depend on what other properties you own, how those have appreciated in value, and what plans you have for those other properties in the future.
- It is imperative that the Trust be set up properly, a written Trust Deed is drafted and that it is maintained properly on an annual basis. This may cost a little money up front but the benefits may far outweigh the costs in the long run.
If you would like to discuss the possible applicability of using a Family Trust feel free to contact our office at:
bill@karnertax.com
www.karnertax.com
T: 905-401-0023 F: 905-892-3543
B.D. Karner Professional Corporation
209 HWY. 20, Suite 1
Fonthill, Ontario, L0S 1E6
