Planning for the Next Generation at the Cabin
Despite the many costs inherent in owning a second residence, after years of making fond memories at the lake, owners and their families grow attached to their cabins. This emotional attachment adds complexity to one of the most important aspects of cabin related tax planning – the process of transferring the property to the next generation.
The best first step is sitting down with your children to discuss their wishes for the future and talk through the costs and responsibilities of cabin ownership. If none of your children are interested in using or owning the cabin, then the planning will likely be limited to considerations of when to sell or donate the property. If one or more children want to continue using the cabin, then you should consider some strategic planning to reduce your and your family’s tax burden. These strategies are discussed below.
Transfer To the Next Generation Now
In some cases it may be best to transfer ownership to your children while you’re still alive. This can be done by gifting, selling, or adding a child as joint tenant. This plan will allow you to avoid probate tax and the time-consuming process of passing the property through your estate. It may also allow for a reduction in capital gains tax in the future if the new owner does not own another property considered their principal residence.
This strategy does come with some downsides. Most importantly, you are giving up at least some control over the property. As well, the cabin could be subject to claims from the child’s creditors or from their former spouse in the event of a divorce. Additionally, capital gains tax on the increase in value of the property will be payable on the date of transfer rather than on your death. This capital gains tax hit can, however, be spread out by transferring portions of the property over several years.
Transfer Into a Trust
Joint Partner Trust
If you and your spouse are both over 65, you can transfer the cabin into a Joint Partner Trust without any capital gains becoming payable. The property will be held in trust and controlled by you or a trustee such as your child during your and your spouse’s lifetime. This Joint Partner Trust will allow you to avoid probate tax and the estate administration process for the cabin. Additionally, there may be a benefit in naming a child as trustee, as they can help manage the property without owning it outright, protecting the cabin from creditors or divorce claims.
The Joint Partner Trust will end when both you and your spouse have passed away. At this point the property will transfer directly to whomever you have named as beneficiary or to a testamentary trust. Capital gains tax will be payable as normal at this time.
In some cases, a second trust can be implemented that will come into effect on your and your spouse’s deaths. This testamentary trust can be set up to provide a trustee with control over the property and over who will inherit the property in twenty-one years. The twenty-one year period, the amount of time that a trust can exist before capital gains tax becomes payable, will allow time for the trustee to determine who among the beneficiaries is most able and willing to own the property. Capital gains is not payable on this transfer from trust to beneficiary and it can even be deferred for a generation if the property is passed to a grandchild. Further, while in the trust, the cabin will be protected from creditors or divorce claims.
One downside to holding the cabin in a trust is that trusts must file annual tax returns whether or not any income is generated by the trust. There are also several reporting requirements that must be disclosed to the Canada Revenue Agency. This entails time and cost.
Joint Ownership Agreements
If the property is being left to multiple children, management frictions will often arise, particularly when expensive repairs or maintenance needs to be carried out. To avoid conflict in these situations, you can draft a joint ownership agreement. This agreement can deal with a number of situations such as who will pay each portion of the expenses and undertake what responsibilities. It can also outline shared use schedules for each recipient and what will happen if one child no longer wants to own a share in the cabin. Joint ownership agreements can be created at any time by the new owners, but it can bring peace of mind and reduce conflict to help draft it while you are still alive and own the cabin.
Questions? Give us a call!
Owning a cabin can be one of the highlights of life. Don’t let unexpected tax issues sour the experience. Give us a call and let’s discuss how to make sure your children and grand-children can continue the beloved cabin tradition for the next generation.