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TIM CESTNICK

Saturday, July 19, 2003

A few years ago, a family by the name of the Robles living in the town of Leon, Guanajuato, north of Mexico City, suffered through numerous home break-ins. Over time, most of their valuables were stolen. Then, in January, 1997, the family placed an ad in the local newspaper to the attention of the robbers who had been breaking into their house and stealing things. In exasperation, but perhaps unwisely, the family begged robbers to stay away, announcing that they had been cleaned out except for the TV, VCR and the refrigerator. Not too swift. You might say that the Robles weren't exactly helping themselves when it came to protecting their property.

Many Canadians are guilty of similarly hurting themselves by failing to protect their properties -- from taxes.

Let's talk about your cottage. There are a number of ways to minimize the income tax hit on a cottage, but I'd like to focus on one specific strategy: Providing your kids with ownership.

The exemption

It's no secret that Canadians can usually shelter a residence from tax using the principal residence exemption. This generally includes the family cottage. The usual rule is that the home or cottage must be ordinarily occupied for personal use by you, your spouse or former spouse, or a child at some time during the year.

Back in 1982, Canadian tax law changed so that a family unit is entitled to claim a principal residence exemption on only one residence at a time.

A family unit includes spouses (those who are married, or living in a common-law relationship, same-sex or not) and any children under age 18 who are not yet married. Once a child reaches 18, or gets married, he becomes his own "family unit" and is entitled to a principal residence exemption.

Wouldn't it be great to multiply the principal residence exemption so that you can shelter more than one property from tax? One way to do this is to become legally separated from your spouse, providing each of you with your own exemption. Now, if your spouse is like mine, she or he may not appreciate this manoeuvre. So, let me suggest another idea. Consider using the principal residence exemptions available to your adult children.

The children

How can you make use of the principal residence exemption available to an adult child? One option is to simply put the cottage in the ownership of your adult child.

If you're just about to purchase a cottage, it can be very easy to put the property in the name of your adult child. If you already own the cottage, you can still transfer the property into the name of your adult child, but keep in mind that you'll be deemed to have sold the property at fair market value when you make that transfer. This could lead to a taxable capital gain, and a potential tax hit.

There are a couple of ways to deal with this tax hit. You could simply claim your own principal residence exemption to shelter the capital gain from tax when you transfer the cottage to your child. You might also consider triggering some of those capital losses you've incurred in your non-registered investment portfolio, which can offset all or part of the capital gain realized on the transfer of the cottage to the kids.

The nerves

Are you a little nervous about the thought of entrusting your cottage to your kids? Not to worry.

There are a couple of ways to protect the cottage. One common approach is to lend the child money to make the purchase or, better still, take back a mortgage on the property.

This way, you'll maintain some control over the property. Keep in mind, though, that there may be land transfer taxes in your province when you take back a mortgage on the property. Check with a lawyer on this issue.

Another approach to protect the property is to use a trust to own the property for the benefit of your kids. As trustee, you can continue to control the property while still taking advantage of the principal residence exemption available to a child. You see, our tax law will allow a trust to claim the exemption provided at least one beneficiary of the trust ordinarily inhabits the cottage and that person has reached age 18 or is married.

Finally be aware that if you choose not to use a trust to own the cottage, there are non-income-tax issues that can arise when transferring a cottage to your kids: You may be exposing the cottage to creditors of your children, family law claims, or bad decisions made by your kids.

Tim Cestnick, CA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, National Tax Services, at AIC Ltd.

tcestnick@aic.com

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