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 cottages located outside of Manitoba. 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. Capital gains amount to the difference between a property's adjusted cost base and its fair market value. 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. Capital gains tax is calculated by applying your marginal income tax rate to 50% of your total capital gains. 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. As its name implies, properties may qualify under the principal residence exemption if the property is the taxpayer's principal residence. This exemption may reduce capital gains upon disposal of the property. 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 were formerly charged in Manitoba on the fair market value of assets in the deceased's estate. On November 6, 2020, probate fees were eliminated in Manitoba. Probate fees vary from province to province, and probate fees remain payable in Ontario at the rate of 1.4% of the fair market value of the assets situated in Ontario. For an estate where probate is obtained in Manitoba but there is a cottage in Ontario, the Manitoba grant of probate would need to be “resealed” in Ontario (meaning certified by the Ontario court) and Ontario probate fees would be payable on the fair market value of the Ontario cottage.
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 does not require probate to be transferred and is not subject to probate fees. Joint ownership is no longer as commonly used for property in Manitoba as a result of the elimination of probate fees, but may result in avoidance of probate fees on property located outside Manitoba, as fees are payable in the province where the property is situated. 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 at that time (i.e. where it is transferred into the name of the parent and one child, the parent may have transferred 50%), 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, exposing the child’s interest in the property to their creditors. Further, the child may become liable for the parent’s income tax liability under section 160 of the Income Tax Act. This section is triggered when a taxpayer transfers property at less than fair market value, and the transferring taxpayer has a tax debt. Care and consideration need 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 their 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 itself in Manitoba, or probate fees for property located outside Manitoba, 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.
Fillmore Riley LLP's Wills, Estates and Trusts Group
We offer planning and litigation services to individuals, fiduciaries, charities and institutions. Many of our planning practitioners are also part of Fillmore Riley’s highly regarded tax group. For more information, or if you have any questions, please contact a member of the Fillmore Riley Wills, Estates and Trusts practice.