Vacation property and your legacy

Pass along memories, not a hefty tax burden

Overlooking estate matters when dealing with your family vacation property can cost you. Having a strategy to effectively deal with capital gains taxes, property ownership and control will leave more of your estate to those you care about.

Whether it’s a cabin, condo or chalet, your home away from home is a treasured escape you enjoy year-in and year-out with friends and family. While you're busy planning your annual trip to your cherished summer (or winter!) retreat or you’ve just closed the deal on your dream home-away-from-home, tax and estate planning is likely the furthest thing from your mind. But it shouldn't be. Owning vacation property brings its own set of financial concerns, especially when it's time to sell or pass it on to your children.

Unfortunately too many property owners fail to plan the transfer of title of their vacation property. In a client survey conducted by BlueShore Financial, over half (56%) of respondents admitted to not having a strategy. Overlooking details when handing down a vacation home can create problems, from an unwelcome tax bill to strained family relations.

By developing a strategy to effectively deal with capital gains taxes, property ownership and control will not only leave more of your estate to those you care about, it will spare them headaches down the road.

Start by having an open discussion

Few assets can stir up emotions like a vacation property. That’s why it’s essential to first discuss your desires to transfer title with those affected most, likely your spouse and children.

Although parents may go in with the right intentions, a lack of understanding and the wrong assumptions can lead to conflict and hard feelings. BlueShore Financial’s research found that even when parents have a plan, the majority haven’t shared the details with their children.

Asking a few key questions can help ensure a happier outcome for all involved.

• Don’t assume your passion for the property extends to each family member. Is every child interested in owning the home? Some might live too far away to make use of it, while others may appreciate receiving cash or other assets instead.
• Like any home, a vacation home represents an ongoing financial obligation. Are you leaving the property to someone who is able to keep up with the taxes, maintenance and other expenses?
• Are there unresolved issues between your heirs that could sabotage your hopes for family harmony? If you and your spouse are acting as peacemakers now, what will happen once you’re out of the picture? Control of a recreational property may offer up yet another reason to fight.
• Take a second look at your retirement readiness and make sure the vacation property is something you can afford to give up in the first place. Are you certain you won’t eventually need the cash the home’s sale could provide?

Timing the transfer

While there’s always the option of transferring ownership of a recreational property through your will, you might choose instead to hand title to your beneficiaries while you’re alive. That way you’ll have the satisfaction of seeing them enjoy the home. That said, there are potential drawbacks to weigh.

Transferring title usually means giving up control of the property. And, if your home’s value has run up with the real estate market over the last few years, expect the ownership change to trigger what could be a hefty tax bill for capital gains.

Strategies for dealing with capital gains tax

In BC, the price of recreational property has soared over the last few decades. Many long-time vacation property owners have enjoyed a dramatic increase in the value of their investment.

A more valuable home may do wonders for your net worth but comes at a price: capital gains taxes. If you've held your property for many years, the capital gains can be significant and can be perhaps the biggest financial headache for vacation property owners when transferring title to their heirs.

Under Canada Revenue Agency (CRA) rules, capital gains are subject to tax at the individual’s marginal rate. A capital gain (or loss) is measured by the difference in the property’s market value and the adjusted cost base, which includes any upgrades or renovations. In 2024, the federal government made changes to the structuring of capital gains taxes. Annual capital gains up to $250,000 are taxed at 50% of the value, however, what’s new from June 2024 is that for any capital gains over $250,000, the rate increases to 66.67%. It is wise to discuss this matter with a tax or accounting specialist so that you are prepared with a strategy that suits your needs. 

Upon death, your assets are disposed of at market value. Consider two scenarios. If you purchased your vacation home for $600,000 and it's valued today at $800,000, you're sitting on a $200,000 capital gain. Half of the gain, $100,000, would be subject to tax. But if you had bought it earlier when prices were lower, at say $200,000, the increase in the property’s value would result in a $600,000 capital gain. Two-thirds of the gain, $400,000, would be subject to tax. If you're in the top tax bracket in BC, your estate could be left with a hefty tax burden.

That could be a significant amount and one that your heirs may not have the resources to pay. It could be devastating if your property with all its cherished memories has to be sold to settle the tax bill.

How can you avoid, offset, or at least defer, capital gains taxes?

1. Roll it to your spouse

If not jointly owned already, one option is to leave your vacation property to your spouse or common law partner, either during your lifetime or in your will. Through this “spousal rollover” any taxes on capital gains can be deferred until their death (earlier if they dispose of the property).

2. Track improvements

Keep careful records of any property improvements or renovations. These expenses can be added to what you originally paid, raising your cost base for tax purposes thereby reducing the capital gain.

3. Take advantage of the principal residence exemption

A principal residence is generally exempt from capital gains taxes. Vacation property can be designated a principal residence, but to qualify you must inhabit it at some point during the year and earning rental income can't be the main motive for ownership.

Foreign real estate can be designated as well. Be aware, however, that American tax laws affecting Canadians holding real estate in the U.S. can be complex, so get professional guidance if you already own or are considering purchasing a home south of the border.

If you're a “family unit” (for example, a couple and minor children) that owns multiple homes, you may only select one property to be your principal residence. 

Compare the capital gains that have accrued on each property and consider designating the one with the larger amount. But remember, any gains that continue to build in the home you don't choose will eventually be taxed.

4. Look to life insurance

A flexible way to cover future taxes that result from selling or transferring your property is through life insurance. By purchasing last-to-die policies for you and your spouse, there'll be enough funds to pay any capital gains taxes when the survivor passes on. Life insurance benefits are paid out tax-free and are usually received sooner by the beneficiaries than waiting for funds from an estate settlement.

5. Transfer ownership now

If you're older or have health challenges, life insurance may be prohibitively expensive or unavailable. If this is the case, transferring title to your family members now can be a sensible move to minimize taxes.

Gifting or selling the property changes ownership, immediately triggering any capital gains and taxes in your name. But any future gains will be taxed in your children's hands when they eventually sell or transfer title. This strategy works best for properties having only a small amount of capital gains built up, such as a recent purchase.

Bringing your children in as joint owners has similar tax consequences, but still leaves you with a measure of control. It's important to develop a co-ownership agreement to govern each party. The agreement should include establishing a decision-making process, assigning upkeep responsibilities and setting a schedule for sharing the property. It should also outline what happens if an owner defaults on their obligations, becomes incapable or dies.

A general point is that once you transfer title to your vacation home, your obligations end – any future capital gains will be taxed in the recipients’ hands. Relinquishing the property has the added benefit of leaving you with a smaller estate, and in turn, lower probate expenses down the road.

6. Set up a trust

When setting up a trust to hold your vacation property, you can name your children as beneficiaries. Then, taxes on any capital gains created during the trust's existence will be deferred until they eventually sell or transfer title.

Since you no longer own the property (the trust does), it won't be included in your estate when you die, saving probate costs. Under certain conditions, trusts can be structured to avoid the capital gains tax hit you'll face when you first transfer the property into the trust.

A trust is flexible, leaving you room in deciding how it should operate. For example, you can mandate that you have exclusive use and control over the property while you're alive. Later on, perhaps you'll be less interested in travelling to the lake and may decide to give up possession to other family members. The choice is yours.

One caveat is the "21-year rule." Property held in trust is generally deemed to be disposed of every 21 years. Any capital gains are also taxable every 21 years. If your children are very young when they're made the trust's beneficiaries, the rule may prevent the long-term tax deferral you were hoping they might enjoy.

If you're considering a trust, seek out professional advice. They can be complicated and expensive to set up; however, they can be a powerful estate planning tool when used properly.

It’s all in the planning

The emotional investment you and your family members share in a vacation home can make it one of the most difficult assets to deal with in estate planning. Once you add taxation from rising property values into the mix, leaving your property to your loved ones can be costly if you don’t have the right plan.

A solution is as close as the team of experts at BlueShore Financial. Contact your advisor and let us help you and your heirs, keep creating wonderful memories for years to come.