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Planning the Future of the Family Cottage

For many families, summer’s first long weekend marks the official kick-off of “cottage” season. And whether you call it a cottage, cabin or chalet, these sanctuaries provide a perfect escape from the hustle and bustle of daily life, offering a backdrop for memorable family gatherings. However, amidst the joy and relaxation, the fundamentals of estate planning and taxation often go overlooked. Neglecting these can transform your cherished retreats into future sources of financial strain and familial discord.

To avoid such pitfalls, it’s crucial to engage with a team of wealth management professionals. They can help devise strategies to protect your vacation properties and prevent them from becoming a point of contention among heirs.

Key considerations for secondary properties:

  • Clarifying the preferences of beneficiaries: Seek to understand the desires of those who will inherit and manage your property in the future.
  • Maintenance and repairs: Consider whether the intended heirs can manage the required upkeep and care of the property.
  • Ownership structure review: How the property is currently owned, and by whom it is owned, can impact future transfers.
  • Tax implications: Be aware of taxes that could be levied on the property, especially if it’s a secondary residence.
  • Cross-border complexities: For properties and/or beneficiaries outside of Canada, additional legal and tax considerations come into play.

Decoding property ownership structures

A thorough analysis of how your vacation home is owned is the first step. Ownership might be through a trust, a corporation, or personal ownership, with each having different implications. Many vacation properties are jointly owned by siblings, which can complicate future plans. Joint ownership can be categorized into joint tenancy or tenants in common, each with distinct rules for the transfer of property after an owner’s death.

For example, if you plan to leave your vacation home to a specific beneficiary, it might pass automatically to another person under the current ownership setup, completely bypassing your will. This can cause unexpected conflicts and legal challenges among your heirs.

Estate liquidity and tax considerations

Reviewing the ownership of your vacation property is important not only for facilitating smooth transitions but also for understanding potential tax impacts. If the Principal Residence Exemption is not available, your estate may face significant capital gains taxes at the time of your passing. This could necessitate the selling of the property to fulfill these tax obligations.

Changes to the capital gains inclusion rate

The 2024 Federal budget proposes to increase the capital gains inclusion rate from the current 50% to 66.67%. For individuals, the increase applies to net capital gains that exceed $250,000 in the year. These proposed changes will be effective for capital gains realized on or after June 25, 2024.

This policy change will likely increase the tax liability for families with a second property, especially if it has been owned for many years.

For example, consider someone who dies after June 25, 2024, owning both a primary home and a vacation property. While the primary home might not be taxed due to the Principal Residence Exemption, vacation property would be considered as sold upon the owner’s death, showing a $1,000,000 profit. Under new rules, the tax on this gain would be calculated as follows: the first $250,000 is taxed at a 50% inclusion rate and the remaining $750,000 at a 66.67% inclusion rate, totaling $625,000 in taxable income.

With these changes in capital gains inclusion rates, if the person was in Ontario’s highest tax bracket (53.53%), the tax owed on the vacation property would increase by about $67,000.

It’s still early days with the new budget, and it is not uncommon for further revisions and amendments to be made to the proposed legislative changes. That’s even more reason to take a measured approach regarding your family cottage and consult with your advisors to assess whether your financial plan adequately protects these illiquid assets.

Managing tax liability through insurance

Life insurance can play a role in helping families shelter the anticipated tax liability if they wish to keep their vacation home. Life insurance can cover the income tax, by providing a lump sum payment, and ensure the property stays in the family.

Tailored strategies for unique family needs

Each family’s situation is distinct, requiring personalized strategies that reflect specific desires and circumstances. At Newport, we are equipped to guide you through the intricacies of property ownership, assist in crafting a robust estate plan, and work closely with your chosen professionals.

To begin safeguarding the future of your vacation home, get in touch. One of our team of wealth management experts can guide you through what you need to know—and do.