(From the July 2024 Edition of eFORUM)

By Jamie Golombek & Debbie Pearl-Weinberg

The capital gains inclusion rate changes announced in the 2024 federal budget are now a reality. As of June 25, 2024, individuals may only benefit from a 50% inclusion rate for the first $250,000 of capital gains in a year, and capital gains exceeding $250,000 are now subject to an inclusion rate of 66.67%. While the government has indicated that these changes are unlikely to affect most Canadians, there may be a significant impact on those who own a second home, such as a vacation property. Let’s review four common scenarios that may arise when a cottage owner passes away.

Scenario #1

Charlotte lives in Ontario and inherited a cottage from her parents in 2001 when its fair market value (FMV) was $350,000. This becomes her adjusted cost base (ACB) or tax cost of the property. She passes away when it is worth $1,350,000. Her spouse predeceased her, and the property passes to her children under her will.

On Charlotte’s death, she is deemed to dispose of all of her capital property, which includes her cottage. She will realize a capital gain on the cottage of $1,000,000 (the FMV of $1,350,000 less the ACB of $350,000). This capital gain will be taxable in the year of death, as her principal residence exemption will be used to shelter a much larger capital gain arising from her city home, also owned at the time of death.

If Charlotte passed away before June 25, 2024 (before the capital gains inclusion rate changes came into effect), assuming the highest Ontario marginal tax rate of 53.53% applies, tax on the cottage capital gain would be $267,650 ($500,000 taxable capital gain at 53.53%). If, however, she passes away in November 2024 (when the changes to the inclusion rate apply), tax on the cottage capital gain will increase to $334,563 ($66,913 of tax on the first $250,000 of the capital gain at the 50% inclusion rate plus $267,650 of tax on the remaining $750,000 of the capital gain at the 66.67% inclusion rate).

Scenario #2

Assume the same facts as above, with Charlotte passing away in November 2024. Charlotte’s children have located receipts showing that their mother made $200,000 in capital renovations to the cottage in 2010. This increases the ACB of the cottage to $550,000 and reduces the capital gain on death to $800,000. Tax on this capital gain will now be $263,190 ($66,913 of tax on the first $250,000 of the capital gain plus $196,277 of tax on the remaining $550,000 of the capital gain). Probing to discover capital renovations that can be included in calculating the ACB of the cottage reduces the tax arising on Charlotte’s death by $71,373.

Scenario #3

Now, let’s assume Charlotte had a brother, Philippe, and they inherited the cottage together as joint owners. They would each realize a capital gain of $400,000 ((1,350,000 – $550,000) / 2) on their deaths, assuming the FMV remains constant from the time of the first sibling’s death until the second passes away. On each of their deaths, the $250,000 threshold would be available. Consequently, tax on the capital gain on the death of each sibling would be $120,443 ($66,913 of tax on the first $250,000 of the capital gain plus $53,530 of tax on the remaining $150,000 of capital gain). The combined tax owing on their deaths would be $240,886, which is $22,304 less than the amount in Scenario #2, where all of the capital gain is taxed in Charlotte’s hands.

Scenario #4

Charlotte’s and Philippe’s adult children enjoy spending time at the cottage with their families. However, although the tax bill on their parents’ deaths has been reduced by remembering to include renovation costs when calculating the capital gain and with each sibling reporting half of the gain, the children fear the cottage will need to be sold to cover the $240,886 of capital gains tax owing between them. If the children recognize this risk before Charlotte’s and Philippe’s death, they can work with their advisor to mitigate it. The cost of $120,443 in life insurance on the life of each of Charlotte and Philipe may be very affordable. In fact, the children could offer to pay the premiums so they can continue to enjoy the benefits of the cottage for years to come.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is managing director, tax and estate planning, with CIBC Private Wealth in Toronto. He can be reached at jamie.golombek@cibc.com. Debbie Pearl-Weinberg, LLB, is executive director, tax and estate planning, with CIBC Private Wealth in Toronto. She can be reached at debbie.pearl-weinberg@cibc.com.