Cottage transfers: advice before action
A family cottage can be a source of many happy family memories. Unfortunately, it can also be a source of estate planning headaches.
Two estate planning issues which commonly arise where family cottages are concerned are capital gains tax and probate fees. Deferral of capital gains tax (other than when a cottage is transferred to a spouse) requires high-level tax and estate planning and will not be addressed in this article. It is common, however, for parents to place a family cottage in joint names with adult children in order to attempt to avoid payment of probate fees on the cottage. This article will address some of the complications that can result where a family cottage is placed in joint names without proper legal advice prior to the transfer.
Capital Gains Tax
Capital gains tax arises when a property is disposed of by its owner. When a cottage owner dies, he or she is deemed to have disposed of the cottage for its fair market value at the date of death. Where a cottage is owned by a couple or an individual with a spouse, in the vast majority of cases the cottage will be passed to the surviving spouse (either as the surviving joint tenant or as beneficiary of the deceased spouse’s estate), and any capital gains tax may be deferred until the death of the surviving spouse.
When the surviving spouse passes away, the cottage will then be subject to capital gains tax. This tax liability can be significant and where the cottage is passed to children and not sold out of the estate, the tax liability must be satisfied from the other estate assets.
It may be possible to claim the principal residence exemption with respect to a cottage but determining the application of the exemption or the impact of a transfer on the exemption is fact dependent and beyond the scope of this article.
Probate fees are charged on the fair market value of assets in the deceased’s estate. In Manitoba, probate fees are 0.7% of the value of the estate assets, or $7 for each $1,000 of value. Probate fees vary from province to province and are payable in the province where the asset is situate.
It is common for a parent to place property in joint names with children so that the property passes directly to the children on the parent’s death as surviving joint tenants without passing through the parent’s estate. The primary motivation for placing property in joint names is avoidance of probate fees since in most cases, jointly owned property is not subject to probate fees. However, placing property in joint ownership can result in unforeseen problems, particularly with respect to capital gains tax.
Capital gains tax cannot be avoided or deferred by transferring the cottage into joint names with children prior to death. In fact, the transfer of the cottage into joint names may be a disposition for tax purposes at the time of the transfer and the transferor parent may be subject to capital gains tax on the portion of the cottage transferred (i.e. where it is transferred into the name of the parent and one child, the parent may have transferred 50%) at that time, resulting in prepayment of capital gains tax. When the parent passes away, there will then be a deemed disposition of the interest retained by the parent and capital gains tax will be payable on that interest. In addition, land transfer tax will be payable on the transfer of the parent’s interest at the time of the transfer into joint names.
Placing property in joint tenancy also has non-tax consequences that may not be desirable. When property is transferred into joint names with more than one child, when the parent dies the children will hold the cottage as joint tenants together. The hallmark of joint tenancy is the “right of survivorship,” which will result in the last surviving joint tenant being the sole owner of the property. Where a family cottage is involved, a situation where the “last child standing” is the sole owner of the cottage may not be the desired result.
Where a parent places property in joint names with an adult child, that child is presumed to hold the property in trust for the parent’s estate and will be required to deal with the property as an estate asset, and the child does not take the property as the surviving joint tenant unless it can be shown that the parent intended the child to take the property on the parent’s death. Where property is transferred to only one or some of a parent’s children, care should be taken that the parent’s intentions in this regard are clearly documented and understood by all children at the time of the transfer of the property so that disputes after the parent’s death might be more easily avoided.
Problems may also arise where a child becomes a joint owner relating to creditors of the child. Care and consideration needs to be exercised to ensure no unanticipated results occur.
Issues concerning sharing of property with a spouse or common-law partner of an owner on separation should also be considered prior to a transfer of a cottage into joint names. While in Manitoba, gifts and inheritances are generally not shareable in the event of a relationship breakdown, if the cottage is considered a family asset or a gift intended to benefit the spouse or common-law partner of a transferee child, the child’s interest in the family cottage may be shareable should the child and his or her spouse or common-law partner separate.
It is necessary to consider all consequences of placing property in joint ownership prior to doing so. It may be that joint ownership is a useful solution that results in avoidance of probate fees and accomplishes the parent’s estate planning objectives. Where property is placed in joint names, however, it is essential to ensure that all potential consequences have been addressed and that proper documentation is in place at the time of the transfer to ensure that the potential for any tax, estate administration, creditor or family law problems is minimized.
Johanna C.C. Caithness is a lawyer at Fillmore Riley LLP practising primarily in the areas of taxation, wills and estates and corporate and commercial law. She can be reached directly by telephone at (204) 957-8301, by fax at (204) 954-0310 or by email at email@example.com