How do I fairly bequeath real estate to my children?

family celebrating

More than three million Canadian couples will pass on an average of one-quarter million dollars to the next generation over the next 30 years. Consider that 50 percent of all personal assets are owned by people of age 50 or more. A question they will ask themselves is how to transfer this wealth to their families?

Transferring property to your children.  Your children will be faced with a host of new responsibilities when they inherit your wealth. They will have to ask themselves: should we sell the house; what assets should we keep or place in storage; which assets should we share and which should we sell?  Canadians who own a cottage or second residence used for vacations may require special tax planning because a cottage or vacation condo is considered to be a secondary residence for tax purposes.  There may be family quarrels over who will pay for a cottage’s or vacation property’s upkeep and use, once you die. Consider your estate-planning directives before you pass on. This preparation will help to prevent confusion and potential family conflicts.

Utilize legal and/or accounting help. If your estate requires special consideration, discussing estate issues with professionals will provide options and guidance for simple-to-complex estates. If you have a cottage or another secondary residence, be sure to include this in your discussions.

Consider these alternatives: 

• Plan to have the cottage/second residence held in a testamentary trust after you die.  A trust is a legal document that allows you to determine what property will be provided for specific beneficiaries upon your passing. You may also set certain conditions to the use of the assets by the beneficiaries.

• Maintain control. Set up a living trust, so that the property won’t form part of your estate at death. A living trust is created while you are alive, and your beneficiaries can benefit from your wishes during your lifetime.

• Or, if the children want the cottage/second residence, give or sell the real estate to them while you are alive.

Understand the result – deemed disposition. When the ownership of a cottage/second residence goes directly to beneficiaries or into a trust, a deemed disposition takes place. This means that if the value of the cottage has increased, capital gains tax may have to be paid.

Consult an accountant to help you determine what tax will have to be paid upon the disposition of the cottage.  Typically, the fair market value of the property, less its total costs, will result in a capital gain (only half of the gain becomes taxable).  However, this gain may result in substantial costs because you could be faced with a higher marginal tax bracket. Tax planning with your accountant is essential.

Advanced estate planning can cover your second residence’s estate tax liability.

So you may ask, how can you pass on the cottage/second residence to your children without a large tax liability? Personal life insurance, purchased with your after-tax dollars, can provide a non-taxable death benefit to pay this tax. For a minimal monthly premium payment, your potential capital gains tax liability on a family cottage/second residence can immediately be covered.

In addition, your life insurance can also pay off any unpaid portion of the mortgage. This can help equalize the estate with other siblings. The person holding the mortgage would be the beneficiary for tax reasons. A joint last-to-die life insurance policy may be the least costly method to resolve the estate inequity. Note: A capital gain is only triggered upon the death of the last spouse, or upon the disposition of the property. 

Estate equalization maneuver.  In some families, not all children may wish to share in the family cottage/second residence. Where there is one child, who – to the exclusion of others – will receive your cottage/second residence, an inequity may occur. Your estate will pay the applicable capital gains tax on your cottage/second residence, thus lowering the remaining assets in your estate for equal distribution among the other children. Therefore, you may want to plan for estate equalization to the other heirs using an increased amount of life insurance proceeds.

Note: Prior to February 28, 2000, the inclusion rate for tax on capital gains was 75 per cent. From February 28, 2000, to October 17, 2000, the inclusion rate was 66 2/3 per cent. Currently, and as of October 18, 2000, the inclusion rate was further reduced to 50 per cent. You may need to treat your capital gains or losses separately, on the basis of these periods and inclusion rates, relative to the time that you realized your capital gains or losses. Consider consulting an accountant when evaluating your final estate tax liability.


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