As the summer comes to an end, we also say goodbye to our cabins and cottages. Many family properties have been owned over generations and there is often a desire to keep them in the family for decades to come. Yet, many children do not have the funds needed to buy the property.
In working with clients, we are often asked questions about cottage/cabin succession planning. One question that is commonly asked is: Can I sell the cottage to my kids for $1, or a value substantially lower than its fair market value (FMV)? This is often to try and avoid the capital gains tax. When a cottage is not considered a principal residence, capital gains tax will generally be due on the difference between the FMV and adjusted cost base (ACB) of the property.
However, selling less than FMV is likely to lead to significant tax consequences. The child’s ACB will be determined by the actual price paid, which may lead to the child paying tax on a gain already realized by the parent when the child eventually sells the property.
Take, for example, a cottage that is sold for $1 to a child. If the FMV is $1 million and the ACB to the parent was $400,000, the taxable capital gain to the parent would be 50 percent of $600,000 (or $300,000). For the child, a purchase at $1 results in the child’s ACB being $1, rather than the property’s FMV.
So, if the property is sold in the future for $2 million, the capital gain would be the full $2 million less $1. This results in double taxation as it includes the parents’ earlier capital gain, as well as the original amount paid for the property. Instead, there may be better options, such as gifting the cottage. Although there will be a substantial tax liability to the parent at the time of gifting, the child’s ACB will be equal to the FMV at the time and double taxation will be avoided.
As always, consult with legal and tax advisors familiar with cottage succession planning to help you understand the options available.