Q: My husband passed away last year and left our family cottage to myself and my three adult stepchildren. Right now, the deed is in my name only.
If I transfer the deed to include all of us, will there be a tax implication? We also all own homes in the city.
Should we get an appraisal done on the cottage at this time?
A: I’m sorry about your loss, Jill. I’ll touch on some of the legal and tax considerations of your family cottage.
You mention that the cottage deed is in your name only right now. That suggests that it was either in your name all along or that the cottage was owned jointly with your husband with right of survivorship. I suspect that it was held jointly with right of survivorship, meaning that it was transferred directly to you on your husband’s death. That means that it passed outside of his will regardless of his wishes contained therein.
Sometimes the ownership structure of an asset trumps a will and this may be a case of that, Jill.
When an asset passes to a surviving spouse on death, by default, it is transferred at its adjusted cost base for tax purposes, meaning no capital gains tax is payable at that time. You can elect to have some of the capital gain taxed on the final tax return of the deceased, if it’s advantageous to do so, but let’s assume this didn’t happen. This means that all the accumulated capital gains have been passed along to you and this is important as it relates to the next steps you take with the cottage.
You may not have a legal obligation to include your three stepchildren in the ownership of the cottage, Jill, since the cottage passed outside the will due to joint ownership. It sounds like there is at the very least a moral obligation to include your stepchildren in the ownership, but it will result in a gift to your husband’s children and therefore have tax implications.
Because the accumulated capital gains have been passed along to you, if you gift three-quarters of the cottage to them, you will personally have a capital gains tax liability in the year of transfer. Some people think they can skirt the capital gains tax by making the gift for $1 or for a value equal to the cost, but that’s not the case. The transfer in ownership needs to happen at fair market value, meaning the appraisal you suggested may be relevant, Jill.
Assuming you have sufficient resources to pay the capital gains tax, you may not be worried. But the capital gains tax bill could be a big one if you’ve owned the cottage for a long time.
Keep in mind there are options. You could treat the cottage as your principal residence, with the transfer to your stepchildren therefore being tax-free. But this would expose your house in the city to capital gains tax on sale or on your own death. You need to weigh the pros and cons here to determine if this is advantageous. You may also be limited in doing so if you had a previous principal residence that you sold during the time you have owned the cottage and you treated it as your principal residence, with no capital gains tax payable.
Another option would be to keep the cottage in your name and have at least three-quarters of the cottage, if not the whole cottage made over to your stepchildren on your death. But this could be a sticky situation if your stepchildren are expecting their share of the cottage now. You may be able to save tax, but you may not be able to save face with your stepchildren if they don’t understand or care for your tax planning.
Either way, I think you need to consider the legal and tax implications of a situation that is not entirely clear cut, Jill. Ownership of assets can sometimes conflict with wills. And cottages more often than cash can be a sensitive area that can lead to family conflict – particularly in stepfamilies.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
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