A family cottage is a place to create memories.

Sunny days spent lounging on the dock. Late afternoon naps in the hammock. Kids shrieking behind a boat as the tube hits the wake. Roasting marshmallows at the firepit.

One of my clients recently came to me looking for a solution to keep their cottage in the family. Holly spent every summer there as a child, running barefoot and wild with her cousins. She learned to swim in the lake, had her first kiss on the dock when she was 14, and beat her Dad at chess for the first time on the screened-in porch. She raised her own kids there, too – watching them build tree-forts and do cannonballs the same way she did. Now, at 60, she hopes to take her 2-year-old great-grandson up to the lake for the first time.

Her mother owns the cottage, but Jane is 88 now and this will likely be her last summer at the lake. She is adamant that Holly keep the cottage so this little slice of heaven could be a cherished retreat for their family for many more generations to come.

But it is not as easy as simply willing or selling the property to Holly.

The biggest and most obvious obstacle to this is capital gains tax.

Jane bought the cottage over 50 years ago. Obviously, the value of this prime waterfront property on a wildly popular and exclusive lake has sky-rocketed since then. Since real estate is a capital asset, this capital gain would be taxed at 50%. With a 500,000 increase in value since Jane purchased it, that would mean a whopping $250,000 addition to Holly’s tax burden. (Even if Jane sold Holly the cottage for far less, the government would see it as sold for fair market value.) Paying that would be out of the question, so Holly would be forced to sell.

So, what can be done to manage capital gains tax?

Principal residence exemption: capital gains tax is not payable on a “principal residence”. If your cottage has increased in value substantially more than your home, you may consider designating your cottage as your principal residence.

Tracking capital expenditures: Over the years, it is likely you will make improvements to the property that increase its overall value or useful life. Adding a deck, or an addition, for example. These improvements form part of the adjusted cost base, which is subtracted from the increased value of the property when calculating capital gains. A higher cost base means a lower capital gain.

Life insurance: A tax-free death benefit from a permanent life insurance policy can be used to help cover the capital gains tax owed on a property,

If you prefer to transfer the property while you are still alive, there are a few options for diminishing the capital gains tax.

Capital gains reserve: payment from the sale of the property is spread over a five-year period. The tax liability isn’t reduced, but being spread out means that you aren’t hit with the full amount at once. As long as the yearly income doesn’t push you into a new tax bracket, government income support (such as OAS) would not be affected.

Promissory note: the property is sold at fair market value, but a promissory note makes up a portion of the purchase price. This note would be forgiven in the will. Effectively, the purchaser would pay the tax cost equal to the fair market value but would not pay off the note.

The countless improvements made to the property (and Jane’s meticulous receipt tracking!) made capital expenditures a factor for Holly and Jane. Combined with a life insurance policy, they have a plan in place to avoid a massive capital gains tax bill.

That means many more summers at the cottage for their family.

There are many options available to ensure that the family cottage actually stays in the family. Book a call with me to see what options make sense for you.