Adam Salahudeen, vice president, tax & estate planning, Richardson GMP
Heather is a 41-year-old securities lawyer at a Toronto law firm. She makes close to $1 million each year and is married with two children. Her parents recently died and she has no siblings.
Heather’s parents left her vacation properties at ski resorts in Utah and Switzerland. Should she keep them, or sell?
The Swiss property will cause multiple tax and administrative headaches. Depending on the canton the property is located in, inheritance tax is either waived, or very low for spouses or children. But if Heather decides to keep the property she’ll face federal, canton and commune taxes.
Salahudeen explains annual tax is approximately 1.3% of the current value of the property. “It’s as if you’re paying rent,” he says
Heather doesn’t have the time, expertise or language skills to handle these ongoing obligations. And it will cost about $5,000 a year to hire lawyers, accountants and property managers.
Further, there’ll be ongoing repair and maintenance costs that can run into the tens of thousands if major work is needed.
Swiss chalet solution
Since Heather only plans to use the Swiss property once a year, it’s difficult to justify the costs. Salahudeen suggests she sell and pay the associated taxes.
Her Swiss tax obligations include:
- a 1.5% wealth tax of the property’s market value;
- capital gains tax between 25% and 50%, depending on the canton the property is located in; and
- a surcharge that can raise the capital gains tax by up to 50% if the property is sold within four or five years of taking ownership, depending on the canton.
Salahudeen notes the capital gains tax rate falls after she’s owned the property for four or five years. This reduction can reach 50%-to-70%.
The Canadian tax rate is 50% of the gain, and thanks to our tax treaty with Switzerland, Heather will avoid double taxation. At minimum, Heather will face the 50% Canadian rate, less any deductions for renovations.
But if an immediate sale pushes the rate over 50% on the Swiss side, it’s cost-effective for her to hold off so she can benefit from the rate reduction regime.
Heather’s advisors must consider property maintenance costs, the amount of gradual tax relief, and a possible increase in property value in that four- or five-year period.
Capital gains are calculated by subtracting the purchase price and any renovation costs (e.g. a roof replacement or remodeled kitchen) from the selling price. So she needs to keep all receipts.
The Utah lodge has personal significance—Heather’s been holidaying there since she was 14. The question is whether she should rent it out while she’s not there.
Utah lodge solution
Renting the property presents an array of costs. Salahudeen notes there’s a 30% withholding tax on the gross rental income. So if the fair market rent is $1,000 per month, the U.S. government gets $300.
And tenants can be nightmares. Heather would have to deal with any problems (e.g. frozen pipes, heating problems)—not easy in the middle of an important trial. So, she’ll need to hire a property manager, and this means fees similar to the Swiss chalet.
The best option is to retain the property without renting. Annual property taxes for the $3.2-million-dollar lodge will run approximately $14,000 because of its size and premium location in ski country.
Help clients keep their cottages
Here are some questions to ask clients who want to pass on their cottages:
- Which children are interested in owning the cottage?
- What’s the impact of passing the cottage to only one child?
- Are the children, spouses, or grandchildren capable of jointly owning the cottage?
- Do any children have the financial resources to purchase it from their siblings?
- Does it make sense to pass on ownership prior to death?
- Are there sufficient estate assets to equalize the value of the cottage with other children?
- Is your client counting on the sale of the cottage to fund his current lifestyle?
Using a trust to hold the family cottage may be appropriate when:
- Parents would like continued access to the cottage throughout their lives but would like to pass on the increase in value, as well as the related tax liability, to future generations.
- The trust agreement should address the ongoing management of the property and responsibility for costs. As part of the trust, the parents may also choose to include a sum of money for the upkeep of the cottage.
- Parents feel the children are not able to handle the financial responsibilities, or have concerns about existing or potential creditors, or situations of marital breakdown.
- Decision making can be simplified by having the trustee make the decisions as to use, upkeep and eventual disposal. This would simplify the process of having consensus on sensitive issues.
- Probate fees will be avoided on death because the cottage will be owned by the trust and not the deceased.
Dean DiSpalatro is the senior editor of Advisor Group.