This summer you and your kids have been fortunate enough to laugh, splash, and create many special memories at the family cottage.  Your parents approach you, as they are aging and feel they no longer want the responsibility of caring for the cottage.  With summer winding down they want to keep the property in the family and offer to sell it to you for $1 . . . have you just hit the jackpot??? 

Here are some things you may want to consider. . .

Capital Gains Tax; This is the biggest concern people face when transferring or selling a cottage to the next generation.  Capital gain is an increase in the value of an investment from the original purchase price.  If the value of the asset increases, you have a capital gain and the taxman will want to collect on that.  Capital gains tax is paid when you sell the property for more than you purchased it for.  So, many mistakenly think this tax can be reduced or avoided by selling or gifting to a family member, for less than fair market value.  However, this can result in double taxation . . . Yes, you read that right!

Here is the reason why.  Regardless of purchase price, when parents sell the cottage they are required to pay tax on the capital gain; calculated as the difference between the property’s adjusted cost base (ACB: value of property when first acquired plus costs of improvements) and fair market value (FMV: what it is worth today).  So, not the generous $1 price tag.  The child’s ACB is determined by the purchase price, and if the property is then ever sold capital gains will be paid again . . . tax the parents already paid.  

Easy then, have your parents gift it to you right?? Not as easy as you may think . . . . keep in mind the taxman must still be paid.  If the cottage is gifted the parents must still pay capital gains tax on the property.  If the capital gains tax was not paid, it would lead to the taxman knocking at the door to collect the outstanding capital gains tax plus interest and penalty upon passing of the parent and settling the estate.

So are there any other options???

Buy a life insurance policy;  Your parents can leave you the cottage in their will, and they keep it until they pass away. Depending on their health, one could obtain a joint-last-to-die insurance policy to pay the capital gains. Sometimes that may be the better solution than paying the capital gains tax today. It depends on their overall financial situation and if they need the money from the sale or not.  Also, keep in mind insurance becomes more expensive as you age, thus best to consider a policy earlier in life.

To sum it all up.  Taxation is based on Fair Market Value of the property regardless of whether they gift it to you or sell it cheap.  If you buy it for less than FMV you may be faced with double taxation.  Many times, the best solution depends on how you want to fund the tax liability.  Consider, who wants to pay the tax bill (parent or child) and when you want to pay the tax bill (now or at time of death).  This type of transaction should always involve your lawyer and accountant to help you determine the best strategy to transfer your cottage to the next generation.