Pain-free ways to pass on the cottage: Capital gains strategies are the focus of part two of Jamie Golombek's look at taxes and

National Post


The principal financial impediment standing in the way of transferring a
vacation property to the kids is the potential capital gains tax payable on any
increase in the property's value from the date of purchase to either the date of
transfer or the date of death.

Tax planning for a second property has only become an issue in the past 25
years. That's because in 1982, the government changed the rules governing the
principal residence exemption.

Prior to that, it was possible for each spouse to own a property and
designate it as his or her principal residence, with the resulting capital gains
tax-free upon disposition. The change of rules meant a couple could only
designate one property between them as their principal residence.

Although numerous planning ideas have been invented to reduce or defer tax
liability on the transfer of the cottage, the most common are the use of life
insurance and transferring property to a trust.

You can purchase a life insurance policy to insure the value of the tax
liability upon death. However, owners often overestimate the amount and the cost
of such insurance.

Take Drew, for example. He's 50, and owns a mountain chalet in Canmore, Alta.
that he purchased for $400,000, which is now worth $900,000. He's sitting on an
accrued gain of $500,000, of which only 50% is taxable. How much life insurance
does he need to cover off the tax liability so he can pass the cottage on to his
kids tax-free?

Using Alberta's top marginal tax rate of about 40%, Drew's tax liability to
be insured is $100,000 (40% of $250,000). The cost of a term-to-100 insurance
policy varies by provider but averages about $1,100 a year if Drew is in good

Practically speaking, life insurance may not always be feasible. If the
cottage owner is in his 70s or older, he may be uninsurable or the premiums
prohibitively expensive.

Another strategy is to transfer the property into a trust to avoid the deemed
disposition of the property upon death. The problem with this strategy is that
unless certain conditions are met so that the trust qualifies as an "alter-ego
trust," a special type of trust, then a transfer of the property to a trust will
trigger immediate capital gains tax.

On the other hand, if you are purchasing a new property or own one that has
little or no accrued capital gains, you may wish to transfer the property to a
trust today so that any future capital gains tax that arises can be deferred
until your children ultimately sell the property.

The trust deed would normally specify that you have exclusive use of the
property during your lifetime and full control of the property as the trustee of
the trust. Later on, when you find you are no longer using the property as much,
you can distribute it to the appropriate beneficiaries.

When it is distributed, the property can be "rolled out" of the trust to the
kids at the original cost base and thus tax would be deferred until the property
is sold by the next generation.

y Jamie Golombek, CA, CPA, CFP, CLU, TEP, is the vice-president, taxation and
estate planning, at AIM Trimark Investments in Toronto.

Colour Photo: Brent Foster, National Post; Planning ahead allows you to pass on
the holiday home to the next generation without the pain of capital gains taxes.