The following is a general summary of information gathered over my years of practice in Parry Sound, dealing with the sale, gifting, of devising by Will of Georgian Bay, Lake Rosseau and Lake Muskoka recreational properties . It is meant to get a family thinking of specifics, and to touch on the most foreseeable of questions, when the topic of what to do with the (shockingly valuable) cottage arises.
Assume you wish to transfer title to the cottage. The following are issues raised when gifting or selling cottage real estate in Ontario. If the owners are non-residents, or unable, or are residents but advised not to, claim the cottage as a principal residence, there is no way to avoid Canadian income tax.
If you are a non-resident, any method of proceeding you select will also have its own entirely separate and not necessarily compatible tax implications in your home jurisdiction, and you should be cautious to dovetail the situation there with what is happening here to ensure there are no surprises. “Residency” means residency for income tax purposes, and not citizenship.
What the current registered owners face
One half the gain in value of the cottage since ownership was acquired is added to the owner’s regular taxable income in Canada in the year in which the cottage is sold, gifted, or passed by Will. Since the highest marginal rates in Canada are about 46%, as a rule of thumb the tax is treated for discussion purposes as being 50% of the 50% brought into income, or 25% of the total gain.
Canadian residents will disclose the transaction, and pay the tax, when filing the return covering the tax year in which the transaction occurs.
Exactly the same final tax is paid as a resident, but for a non-resident the procedure is substantially more complex.
As a purchaser (or donee), the owners should be required to deliver a certificate issued by Revenue Canada as evidence that the transfer has been reported and that the appropriate withholding tax for Canadian income tax has been paid. Until the certificate is produced, the government of Canada has a lien on the property for one quarter of its total value, or the sale price, whichever is greater. (I call this the "penalty tax.")
The withholding tax much is much less than the penalty tax. The withholding tax is 25% of the unadjusted capital gains accruing over the taxpayer’s ownership of the cottage, or since January 1, 1972, whichever is the shorter. For residents of the United States, the tax is computed with respect to your property under the provisions of the treaty between our two countries - the Canada-United States Income Tax Convention, 1980, as now amended by a number of protocols.
If the property was owned prior to 1980, there are advantageous “grandfather” calculations which can still be made to minimize the withholding tax and the ultimate tax being paid to you. These calculations are of reducing significance since 1985, but still represent some tax saving. It remains roughly a tax of approximately 25% of the gain in the value of the property.
An initial calculation of gain is made when applying for the clearance certificate, and the 25% withholding tax, as calculated with supporting appraisals or sale particulars, is payable.
Withholding tax is payable within thirty days of the transfer of title, so it is always best to have the tax situation fully in hand before registering the deed.
After withholding tax is paid, a personal Canadian tax return is then filed for the taxation year in which the transfer is made to compute the precise tax payable (taking into account such costs of disposition as appraisal costs and attorney’s fees) and a refund of a portion of the withholding tax (if any was paid) is processed by the tax department in your favour.
If the disposition is by way of gift or by Will, tax is calculated using the Fair Market Value as of the date of the gift or the date of death. If disposition is by way of Will, there is the added “fee” (treated by estate planners as a tax) of 1.5% of the probated value (in this jurisdiction) of the estate. On death, capital gains tax is calculated as though the property was sold at fair market value immediately prior to the time of death.
If a husband and wife hold ownership in their names alone, as joint tenants, then on the death of one of them the deceased's interest "rolls over" to the surviving spouse, and no tax is payable until the survivor deals with the property, by gift, sale, or Will. In unusual circumstances, it is possible and desirable to cancel the rollover.
If the disposition is between other family members, even if money changes hands, the government will expect a current valuation of the property to be filed. The assessed value will give you an idea of the value, but is not considered acceptable by Revenue Canada for our purposes.
The gain is the current value less the value at the time of acquisition or January 1, 1972, whichever is the more recent. The acquisition cost is adjusted by adding the cost of any capital improvements made over the time of ownership (new roof? New septic? etc.) The adjustment for capital improvements does not need, initially at least, to be supported by invoices, although Revenue Canada (called the "CRA") may of course challenge the claim. In my experience, reasonable claims are accepted at face value. Qualified local realtors are able to give an opinion of 1972 value, if one is needed.
In recognition of US gift tax implications, some families elect to gift fractional interests over a series of years. Breaking up the gift like this also makes use of Canada's progressive tax rate, but savings need to weighed against the costs of repeated legal and accounting (and perhaps appraisal) costs.
The foregoing process is my understanding of the tax implications of a disposition of recreational real estate. This office does not calculate the tax or make the tax filings. Any chartered accountant in Parry Sound deals regularly with this situation.
Issues for the purchaser/donee/children
A lot of expensive legal talent has been brought to bear on how best for non-residents to hold title to exclusive cottage property. Loopholes come and loopholes go, and focusing on tax issues only is probably a mistake.
Happy memories of family summer life often colour estate planning discussions. “The cottage is to be kept forever”. Trees are planted and grandpa’s ashes spread – both of which are legal, by the way.
Some families elect gifting fractional ownership over a series of years
A transfer to a corporation potentially attracts an annual taxable shareholder's benefit equal to the fair market value of the rental of the property over the taxation year.
With rare exceptions, a transfer to a trust, whether revocable or irrevocable, triggers the usual tax at the time of the transfer to the trust, and the asset is further taxed every 21 years as though the asset was sold by the trust at fair market value at that time. This information is usually enough to rule out the trust method of title holding, but there are the advantages of continuity of ownership and control by the trustees over competing claims to use and entitlement.
Both corporations and trusts are separate taxpayers, and have their own accounting, tax filing and disclosure obligations.
For non-residents, remember that out-of-province corporations (including banks and LLC’s) have no capacity to hold real estate in Ontario unless they go through a process (there are a couple of choices) to be recognized by, and submit to, Ontario law.
My general recommendation is to keep it simple. Give or bequeath by Will the cottage to the children. Period. Let them work out their problems when the parents are no longer involved. Everyone understands the process. You can refine this general conclusion, by, (among many other permutations)
AMERICANS Holding the property until death of the last surviving parent
American testamentary trustees are often Banks; a non-resident Bank does not usually have the power to hold real estate in Ontario, so do not make a US financial institution the executor of a Will dealing with Canadian recreational property without very careful investigation. The property dealt with in the Will should also not be given to an existing American trust, but simply conveyed directly by the personal representative to the intended heir. Most cottage titles in my area are recorded in the Land Title system, which does not recognize trusts.
Whether the property is held until death, or gifted earlier, the Canadian income tax calculations are exactly the same. There may be more funds available, however, to pay tax following the death of the last surviving parent than there are while the parents are alive.
ONE POSSIBLE SAVING
I am able to perhaps assist in the avoidance of estate administration tax (formerly probate fees). This is a tax of approximately 1.5% of the gross value of all Ontario assets. If the only assets in Ontario are the cottage, boats and contents, then the owners can add one or more adult children to the deed as joint tenants, and have the added children sign a simple "bare trust" agreement acknowledging that the parents continue to be the only beneficial owners of the property. Canadian income tax authorities acknowledge that this is not a taxable transaction.
The children who are the trustees acknowledge in writing that they will honour their parents wishes during their lifetime, and will deal with title to the property in accordance with the provisions of the last surviving parent's Will on his or her death. The trustees have no discretion, power of appointment, or obligation except to follow the instructions of the parents. So long as no other assets need to be probated in Ontario, the children simply transfer the property in accordance with their parents wishes (as set out in the Will) entirely outside of the supervision of the Ontario court monitored estate process. Probate fees of 1.5 percent of the gross value of the Ontario assets do not need to be paid. All legal costs associated with the estate administration process in this jurisdiction are also avoided.
Ideally, the children who are trustees also happen to be the children who inherit by Will. On the last surviving parent's death, the legal title recognized by our land titles system and the beneficial owners established by the provisions of the Will, coincide! No further deeds (dealings with title) or probate (dealing with the Will) are needed.
The death of the surviving parent still triggers a valuation and the payment of capital gains tax, even though no transfer of title, in the usual sense, takes place.
It is important that the bare trust arrangement be disclosed to and discussed with the testamentary heirs who are not listed as owners.
Your situation in particular
To move from the generalities to specifics with a situation, I shall need a legal description for the property to check the title. Often there are long forgotten glitches which need to be tidied up as a part of the title transfer process. A faxed, or scanned and emailed, copy of the municipal tax bill is sufficient for me to locate the property.
I shall also need a mailing address for billing purposes, and confirmation that I am acting for you as the proposed transferee, rather than for your parents. Usually in the final result it makes no difference whatsoever, but in the event of conflicting instructions, I need to know to whom I am responsible. Lastly, I would ask for a retainer of $1000 Canadian, or its approximate US equivalent. My hourly rate in 2011 is $340 Canadian.
AND THE COST IS
A "normal" non-resident gift from parents who are not separated to one child would usually involve a legal account, in all, of something near but under $2000. The simplest of situations, which is extremely rare, involves conveyancing costs alone, where everything can be done for $750. If the matter evolves to a bare trust arrangement, you are probably looking at an additional $1,000. Family situations vary wildly from one to another, however, and my fees, and your Canadian accountant's fees, will vary depending on the time involved in dealing with you and your particular family situation.
There is also a move afoot to require the parents giving and the children getting to be represented by different Ontario solicitors authorized to participate in Ontario's electronic title registration system. This is not yet "law" but may suddenly come into the picture.
Once you have digested this, and have decided to proceed further, I would expect you to contact me by telephone or email, or preferably have everyone meet with me by appointment when you are otherwise in the area, and we can review your personal situation more fully. Please note I seem to need lead time of three weeks or so for an appointment.
So we don't get off on an unproductive tangent, my next step for you should be checking the title, to be sure you are in the Land Titles system, and there are no glitches on title.
The actual title transfer papers can be completed and signed in Parry Sound, and registered, in probably 5 working days.… it is getting valuations, and tax advice, and then deciding "what to do" that seems to take the time.
I trust the foregoing observations are of assistance to you.