Many Canadians expect to leave vacation property in their wills, but the rapid rise in real estate values could leave them or their heirs with a major tax bill, says Jamie Golombek, managing director, Tax and Estate Planning, Wealth Advisory Services at CIBC.
“If you plan to sell or pass down real estate to the next generation you may be subject to a host of tax and estate planning issues that could not only cost you or your heirs a lot of cash, but could even force the sale of the property,” warns Golombek.
“Advance planning may help to avoid the capital gains tax altogether or defer paying it as long as possible,” he says.
A CIBC poll found that 70% of those Canadians expecting to leave assets plan to pass down real estate upon their death. When it comes to having conversations about transferring wealth, the poll also found many Canadians had not discussed it with their family or a financial advisor.
“The first step to the successful transfer of real estate is to initiate an open, honest conversation with your family,” says Golombek. “This is particularly important when planning for the transfer of an asset such as a home or cottage where children’s plans for the future might not always align with parents’ expectations.”
The key to deciding how best to transfer your property is to understand how the gains from the disposal are taxed: A principal residence will not trigger capital gains and home owners are free to decide which property they designate as their principal residence, Golombek advises.
“Even though you may have a property that you consider to be your principal residence, such as the family home where you live most of the year, another property, such as a cottage or even a vacation property located outside of Canada, can be your principal residence,” he says.
The principal residence exemption (PRE), however, can only be applied to one property per taxation year. If the gain from the sale of a property is not reported on your tax return, it will be assumed that this was your principal residence for the years you owned it, precluding you from using the exemption for your other property for the years of overlapping ownership.
“You should make a conscious decision whether or not to claim the PRE when you dispose of a property,” cautions Golombek. “Considering the past appreciation in value and the potential for future increases, it may make sense to save the PRE for the property with the most gains.”
While capital gains on the disposal of a second property cannot be avoided altogether, there are strategies to reduce or defer the tax liability, including life insurance, the use of a trust or a corporation.