Saturday, May 27, 2006

Estate Planning for Vacation Properties

In a time when ski chalets at British Columbia ski resorts such as Big White and Silver Star can sell for a million dollars or more (substantialy more in Whistler), and prices of lakefront properties in the Okanagan and in other parts British Columbia have soared, estate planning for vacation properties has become more important. (Yes, I am trying to do my part for the local tourism industry in this post, but the rest of the post is legal and tax stuff.)

The biggest problem may be taxes. The basic rule under the Canadian Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), is that you will be deemed to have disposed of your vacation property at fair market value on your death . This can trigger tax, usually capital gains tax. This means that on your death, your personal representative will have to claim 50 percent of the increase in value of the property since you purchased it as income on your terminal income tax return. (I am assuming your cost base for tax purposes is the same as the purchase price for the purpose of illustrating how the tax works. There are special rules if you purchased the property before the federal government brought in capital gains taxes in 1971.)

Tax may be avoided if your vacation property qualifies as your principal residence, in which case you, or on your death, your personal representative, can claim the principal residence exemption. However, you must ordinarily inhabit the vacation property, and you and your spouse (or common-law partner) may only have one principal residence at a time. (For the years before 1982, the you and your spouse may each claim a principal residence.)

If you leave your vacation property to your spouse or common- law partner, or to a trust for your spouse or common-law partner that complies with the Income Tax Act rules for spousal trusts, the tax may be deferred until your spouse sells the property or dies. Under the Income Tax Act , a person who lives with you in a conjugal relationship for a period of at least one year is treated in the same way as a spouse.

Usually, the tax problem kicks in on the death of the last to go of you and your spouse, and you want to leave your assets to your children (or other beneficiaries). If your personal representative sells the vacation property, then some of the proceeds can be applied to pay the tax. But if you wish to leave the vacation property to your children for them to enjoy, you will need to have other funds, or assets that can be sold, in your estate to pay the tax.

It is important to keep the potential taxes in mind if you wish to leave your vacation property to one of several children. The capital gains tax in respect of the vacation property will come off the top of your estate, reducing the amount available to leave to your other children. Although in theory you could put a provision in your will requiring the child who inherits the vacation property to pay the taxes attributable to the vacation property, this may be difficult to apply in practice. One half of the capital gains on the vacation property gets lumped in with other income on your terminal tax return, and the amount of tax is calculated on the basis of all of the income reported on that return.

If you are inclined to leave your vacation property to more than one of your children consider whether all of them will use it. Will they be able to agree on things such as who gets to use it when? How will expenses be shared?

Be very cautious about transferring vacation property in a joint tenancy with one or more of your children. There are many reasons why transferring real estate into a joint tenancy with your children can be a bad idea. If a child has debts, his or her creditors can file judgments against the child’s interest in the vacation property and apply to have it sold. On a marriage breakdown, the child’s former spouse can make a claim in respect of the vacation property.

In addition to these issues, when you transfer an interest in the property to one or more of your children, you may trigger immediate capital gains tax, calculated on the basis of the fair market value of the interest that you are transferring. For example, if you transfer your vacation property from your name into a joint tenancy with one child, Canada Revenue Agency may take the position that you have disposed of a half interest in your vacation property, and will have to pay taxes in respect of the capital gains on that half interest. This is so even if your child is not paying you anything for an interest in the vacation property. Make sure that when you are making a gift to a child, you are not also making an unintended gift to Canada Revenue Agency.

No comments: