If you’re like many Canadians, you will probably hold your real estate assets — your home, farm or vacation property — for many years. Eventually, however, you will decide to either sell or leave your real estate to your heirs. Determining what to do with your property is the cornerstone of any estate plan.
Like any asset, your property had value the day you acquired it, whether by purchase or inheritance. Because property generally becomes more valuable over time, on the day you dispose of your real estate by selling it or transferring it through your will (which for tax purposes is treated the same as selling it), it may be worth more than when you first acquired it. The increase between the initial value of a piece of real estate plus any capital improvements you’ve made (known as the adjusted cost base) and the selling price is taxable as a capital gain, and must be reported on your income tax return.
“The good news is you don’t have to pay capital gains tax if the property is your principal residence,” says Cindy Crean, Managing Director, Private Client at Sun Life Global Investments (Canada) Inc. “A family unit — a couple or an unmarried adult — is allowed to claim only one principal residence. You have to ‘ordinarily inhabit’ the residence for it to qualify.”
That means that rental properties or vacant land don’t qualify as your principal residence and capital gains taxes apply. Under some circumstances, you may be able to use your principal residence exemption on your vacation property, however. This may make sense if you own a large summer home and a small condo in town, for example.
Unique tax treatment for farms
Farmers receive unique tax treatment compared to other business owners. Special provisions of the Income Tax Act allow Canadian farmers to pass the family farm down to the next generation relatively tax-free without triggering capital gains. Provided the rules are met, the tax liability on the farm property can be deferred as long as the farm business stays within the family — which could be indefinitely.
In addition to this, farmers have access to the lifetime capital gains exemption.
“If the property is eligible for the lifetime capital gains exemption, farm owners could receive up to $800,000 in capital gains tax-free in 2014. The exemption is indexed for inflation going forward,” says Allison Henkell, tax partner at BDO Canada.
These measures can help ease inter-generational transfers within farming families, particularly given the spike in land values. It’s not always clear-cut which properties qualify, however.
“With more and more farms becoming agri-businesses, we sometimes run into situations where people don’t qualify,” says Henkell. “It’s important to start planning long before you’re actually looking at selling.”
When it comes to estate planning and real-estate transitions, preparation is the key.
“The best advice is to be proactive when planning to sell or transition your assets and to think of it as a process rather than an event,” says Crean. “A little planning now can go a long way toward ensuring a smooth, tax-efficient transition of your assets to the next generation.”