Do you own a home or vacation property? Are you looking to buy a cabin or ski chalet? During these years of COVID-19, people are looking for recreational property.
How do you own the property? This is worth a solid look or review. Ownership can be in one person’s name or two or more.
If a home is owned by just one person, it is simple. You own it and can sell it at any time and pay taxes accordingly.
If a home or property is owned by two people, it is more complicated. The home or recreational property can be owned in two ways – ‘Tenants in Common’ or ‘Joint with Rights of Survivorship’. The biggest difference between these two types of joint ownership is what happens when one owner dies.
If property is owned ‘Joint with Rights of Survivorship’ and one owner dies, the home or cottage transfers automatically to the surviving owner. No need to change title or administer the asset through the estate of the deceased owner. This is a smooth and simple succession of the home or property.
When ownership of a home, cabin or property is ‘Tenants in Common’, then each owner owns a percentage. For example, if Sally and Frank own their property ‘Tenants in Common’ and Sally dies, then her 50% is passed through her will and given to the beneficiaries named in her will. If you own property in this way, is this how you want it transferred?
Your Principal Residence
You receive the biggest tax breaks by owning a home as your principal residence.
When you sell your principal residence, there is a capital gain (sale proceeds minus initial purchase cost). For example, if you bought your home 10 years ago for $325,000 and sell it today for $975,000, your gain is $650,000. All the gain is tax-free if the home qualifies as your principal residence.
Your Recreational Property
Recreational properties or secondary residences can be summer cottages or ski chalets and these properties are treated much differently for tax purposes. When you sell the cabin, cottage or property, the gain is taxable. It is calculated like this, using the same figures as above. The gain is $650,000 and 50% or $325,000 is included on your tax return as a ‘capital gain’. Therefore, if you are in the 20% tax bracket, then you pay an additional $65,000 in taxes. If you are in a high tax bracket, then your additional income taxes would be about $150,000.
The biggest issue that many people are not aware of is that the recreational cabins and property don’t need to be SOLD to trigger this capital gain.
If the owner or owners die, then this capital gain has to be reported and income taxes are due. This may be a big problem, if the family is not prepared.
Imagine if these numbers were different and many families find themselves in this situation. The summer cabin was bought in the 1960’s for $25,000 and still owned by Mom, who is now in her 90’s. The value of the cabin is now $950,000. When Mom dies, the capital gain is $925,000 and 50% of this amount is included in her tax return. If she is in a high tax bracket, then the additional taxes owed is about $213,000.
Are you prepared for this tax bill? There are solutions to discuss with the family.
Selling the property may not be the desired option in order to pay the income tax bill.
Money from a RRIF or investment accounts can be used to pay the income taxes.
An insurance policy can be arranged to handle the taxes and the proceeds are applied to pay the taxes. This may be the most cost effective way to deal with the issue.
Holiday homes are places to gather family and friends to enjoy outdoor adventures and create wonderful memories. With planning, the cabin can remain in the family for generations.