Cottage memories may be priceless, but the property itself is not.

For cottages owned for decades or extensively renovated, current market value in fact may be several times the original purchase price.

That means a hefty tax bill, eventually, since most cottages won’t qualify for the principal-residence exemption, which is normally reserved for a family unit’s main residence.

“If you’ve used the principal-residence exemption on homes you sold over the years, then by default, the cottage will be taxable (upon disposal). At some point, you’ll have to pay the piper,” said Christine Van Vauwenberghe, a tax expert with Investors Group.

The eventual tax bill is not the only reason cottage owners had best have a plan. Family dynamics is another.

“It’s unfortunate, but some of the most bitter family disputes involve what’s supposed to be a place of serenity,” Van Vauwenberghe said.

Parents may wish to keep the cottage in the family and leave it to their kids, but the reality is that some, or all, of the children may not want it.

“The fact they like visiting in the summer when the parents are there doesn’t necessarily mean they’ll want to do it without them, especially if they live far away,” Van Vauwenberghe said.

If there is a difference of opinion on the future of the cottage, it’s best to sort it out beforehand, then get professional advice, she said.

“Many families avoid the subject because it can get emotional and lead to arguments, but you need to have the talk. Don’t assume everyone wants it, or nobody wants it.”

If some children want to retain the property and others not, parents can structure their estate plans to compensate those opting out, Van Vauwenberghe said. Extra insurance may be one way to cover the tax liability or equalize the inheritance.

If the property is shared, the children may need an agreement on future occupancy, cost-sharing and maintenance responsibilities, to head off potential disputes. “Some families are good at sharing, for others it doesn’t work as well,” Van Vauwenberghe said.

Cottage owners also are advised to keep a log and receipts of any and all capital expenditures made to their properties. “A new coat of paint doesn’t count, but if you built a dock or replaced the kitchen, that could be sizable,” Van Vauwenberghe said.

Over decades, the sums add up, and can help reduce the capital-gains tax owing when the property is sold or transferred. Receipts, however, will be no use to anyone if just randomly tossed in a shoebox.

Since a cottage transfer is considered by tax authorities to be a disposal at fair market value, there’ll be money due even if it’s a gift or legacy from parent to child. But the tax obligation can be spread over five years if the transaction is concluded in instalments.

The worst thing people can do is sell for $1, Van Vauwenberghe said. “It’ll still be treated by CRA (Canada Revenue Agency) as if it was sold for fair market value, but the buyer’s cost base will be $1 (rather than market value).” That’ll mean double taxation when he or she sells.

http://www.canada.com/business/Planning+family+cottage+could+help+avoid+hefty+bill/5193808/story.html

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