Summer is upon us, which means spending longer days in the sun and enjoying your cottage with your family and friends. If you have decided to bequeath your cottage to your children in your will, you may know that there could be substantial capital gains taxes due. Where does the money come from? Let’s consider some alternatives.
1. Your estate or children could pay the income tax liability from current funds
- Are there funds available?
- What’s given up by you or your children to pay the taxes?
- Typically, the best estate assets are sold first to minimize liquidation losses.
Unfortunately to preserve as much of your estate as possible, liquidation may force you to sell your most prized assets to protect the rest. Only they will command the highest price when cash is needed fast.
If the intent is to keep the cottage in the family, does the will give explicit instructions as to which assets are to be sold to pay tax liabilities?
2. Money could be borrowed to pay the tax
- Would credit be readily available?
- Would the borrowers have adequate cash flow to repay the loan with interest?
- What would the non-deductible interest rates be?
3. Money could be paid in installments after your death
- Would your estate or your children be able to provide the necessary security to the government?
- Would your estate or your heirs have adequate cash flow to repay the amount owing with interest?
- What would the interest rates be?
4.Use appropriately designed life insurances to pay taxes
- Income tax liabilities arise on death and life insurance creates immediate, tax-free cash to provide a solution.
- Joint second death protection provides a very economical way to provide cash to your estate when the second spouse passes.
- It can be custom designed to handle your needs and values.
- Consider having your children own it and pay for it. After all, they benefit from keeping the property.
- The policy can be set up to mature or be paid out when both parents have passed away.
You may be pleasantly surprised at your ability to qualify for coverage. This alternative pays off any capital gains and associated costs of keeping the family cottage and property in the family. It can help equalize inheritances if the cottage property is not shared amongst siblings.
Let’s assume a husband (58) and wife (56) which intend to pass the family cottage down to the next generation at the time of the passing of the second life.
|Calculation figures for capital gain||Values for husband and wife|
|Fair Market Value (FMV)||$ 1,000,000|
|Adjusted Costo base (ACB)||$ 500,000|
|Capital Gain||$ 500,000|
|Taxable Capital Gain||$ 250,000|
|Tax Payable on Capital Gain*||$ 133,825|
* Assuming top personal tax rate in Ontario (53.53%)
|Life Insurance Policy Husband-Wife Joint Last to Die*|
|Coverage Amount||$ 134,000 (tax payable on capital gains)|
|Annual Payment||$ 8,506.74|
|Total Annual Payments||8|
|Total Net Outlay of Payments||$ 68,053.92|
|Coverage amount (20 years)||$ 197,333|
|Guaranteed Cash Value (20 years)||$ 75,384|
*Permanent participating (PAR) life insurance policy, designed for estate protection, with potential for dividends. This particular insurance plan works well as the coverage amount increases throughout the years.
**Life insurance saves the estate $65,771.08 and values will continue to grow along with the increasing Capital Gains growth. It may also be used as part of a tax efficient insured retirement income plan.