OTTAWA - Sitting by the lake and watching the grandchildren cannonball off the dock might be the dream of many cottage-owning baby boomers.
But handing down the cottage to those grandkids so that they might one day do the same can trigger big tax bills that could force the sale of the property.
A lakefront cottage purchased for a few thousand dollars decades ago may now be worth hundreds of thousands, perhaps even more.
And while you can't avoid the tax bill, there are ways to make it more manageable.
Mike Laughton, a financial planner at Royal Bank, says one option is to sell or gift the property to your children today.
While that triggers a tax bill now, it puts any future capital gains in the childrens' hands.
"The sooner you can get it into the beneficiaries' names, the less future tax liability you're going to incur upon yourself," Laughton says.
You can even structure the sale so that you loan the money to your children to buy the property from you. By holding the mortgage, you will be able to spread the capital gains and the associated tax bill over five years and you can forgive the debt in your will if you're feeling generous.
Other options can also include adding your child as a joint owner or transferring it to a trust that could help avoid probate fees when the property is passed through an estate.
To help minimize your tax bill, you'll also want to be sure that you've included all the eligible costs when determining your capital gain.
In addition to the purchase price, real estate commissions, legal fees and other costs related to the purchase of the property can be added. Ongoing maintenance costs cannot be included, but building improvements such as new rooms or expanding the deck may also be added when calculating the adjusted cost of the property.
Jamie Golombek, managing director for tax and estate planning at CIBC, said you might also want to consider declaring the cottage your principal residence to shelter the capital gains from tax.
"However, most people have a home in the city and they also have a cottage and that's where the issue comes," he said.
If you decide to use the primary residence exemption for your cottage, it will mean that you would be unable to use it for the sale of your home in the city for the overlapping years.
Golombek noted the decision to use that exemption will depend on a number of factors, including the average annual gain on each property, the potential for future increases in the value of the unsold property and the anticipated holding period of the unsold property.
If you don't like the idea of giving up ownership of the cottage while you still live and breathe, you can pass it down as part of your estate. But when you die, it will trigger a tax bill as if you've sold the property.
If there won't be money in your estate to pay the tax bill, you might want to consider taking out a life insurance policy that can be used to pay the tax bill. You could even have the children who will inherit the cottage pay the insurance bill.
However, such a life insurance policy may be prohibitively expensive depending on your age and how much coverage you're seeking.
Selling your cottage to your children for a nominal amount that would not otherwise incur a capital gain won't avoid the tax.
The Canada Revenue Agency will calculate a capital gain based on the fair market value even if you sell the property to your children for just $1. And if or when your children eventually sell the property, the tax man will use the nominal price they paid you to calculate the tax bill when they sell.
Laughton added that while the financial aspects are important, you also need to consider the "soft" issues when it comes to a cottage.
If you have more than one child, splitting ownership can be a source of conflict between siblings, so Laughton says you need to talk to everyone involved to ensure a plan that works on all fronts.
"It is not just the tax liability, it is also making sure that the family's happy and that ultimately your goals get accomplished," he said.