Keeping the Family Cottage…in the Family

With the recent real estate boom in BC, cottages and other vacation properties have increased significantly in value. Properties that have been held for many decades will generally be worth substantially more than their original purchase price. At death, 50% of this appreciation will be subject to tax.   It’s a tax time bomb that many people are unaware of and fail to plan for.

A lack of proper planning could mean that your family cottage won’t stay in your family. Since taxes must be paid before your heirs can receive anything from your estate, your family may be forced to sell the cottage to simply pay the tax!

Case Study
Jim and Sandy are the proud owners of a lakeside cottage at Shawnigan Lake. This getaway has provided many memories together as a family including countless Christmases, Thanksgivings and summer holidays in between. Their three children are now grown and have children of their own and the family cottage continues to provide a special place to connect as a family, reminiscing about the past and forging new memories together. Jim and Sandy wouldn’t trade this time spent together for anything.

However, a recent discussion with their insurance advisor has revealed that they have some important planning to do if they want this family tradition to continue for future generations. Jim and Sandy’s cottage was purchased for $350,000 decades ago and it is currently valued at $850,000. Jim and Sandy are both 65 years of age and expect to live until age 95. Assuming the value of the property continues to appreciate by 3% annually, their property will be worth over $2,000,000 by age 95 resulting in roughly $400,000 of tax upon second death.

Jim and Sandy have the following basic options to fund this $400,000 anticipated tax bill.

1). Start Saving Today
Jim and Sandy could establish a savings plan to pay the tax. If we assume that Jim and Sandy are taxed at the highest marginal tax rate and they could earn 4% interest on their investments, then they would need to set aside $9,700 each year for the rest of their lives in order to accumulate $400,000 by age 95. However, a major pitfall with this strategy lies in the unknown timing of Jim and Sandy’s deaths. The total cost over their lifetime would be $288,300.

2). Rely on Borrowing from a Bank
Jim and Sandy could rely on their estate or heirs being able to secure a loan to satisfy CRA. Based on a 10-year loan at a 6% interest rate, it would take $54,347 per year to repay the $400,000 loan.   That’s a total cost of $543,470.

3). Sell the Cottage
Jim and Sandy could rely on selling their cottage at death to pay the tax liability, however, this will not accomplish their goal of keeping it in the family for future generations. Under this scenario, there would be additional expenses associated with selling the property. If we assume these expenses to be only 5%, then their $400,000 tax bill would actually cost them $421,000 at death.

4). Use Life Insurance
Finally, Jim and Sandy could purchase a $400,000 joint-last-to-die life insurance policy in the amount of $400,000. Purchased on a fully guaranteed 10-pay basis, this policy would cost $17,633 for 10 years. A total cost of $176,330.

Summarizing the Options
Since the cost associated with each option is expected to occur at different points in time, we need to translate each cost into present dollar terms in order to make an apples-to-apples comparison. The table below summarizes each cost in today’s dollars.

When in good health, life insurance is often the most cost-effective and predictable solution for addressing taxes at death. Life insurance provides cash to pay the tax at the precise moment it‘s needed, while ensuring that the next generation is not forced to sell the cottage in order to raise money for the taxman.   As we can learn from Jim and Sandy’s example, a little proactive planning will not only cost significantly less but it will also give them peace of mind knowing that their family cottage can be kept in the family.