The abundance of water and land in Canada has afforded many Canadians a "summer home on the water." Families who own both a house in town and a cottage, in effect own "secondary" real estate, which is subject to capital gains tax upon "disposition," and the gains can be significant with property values increasing every year. With good planning though, the cottage can be kept for the next generation if that is the family wish. Disposition, or "deemed" disposition, for income tax purposes occurs in the following circumstances: When the property is sold to a third party outside the family. Upon death of the sole owner. Upon death of a surviving owner in the case of a jointly-owned property. When the title of the property is altered to add another person or people to the title (e.g. adult children). When ownership is transferred completely to the next generation before parents' death. When cottage is transferred into a trust. Capital gains are calculated by subtracting the adjusted cost base (ACB) of the cottage from the fair market value (FMV), or (reasonable) sale price, at the time of disposition. The ACB is the original cost plus the cost of capital improvements over the years (not normal repairs). Owners may contact Canada Revenue Agency to ask for the Rental Income Tax Guide that explains what kinds of expenses qualify as capital improvements, in general. One-half of the capital gain is tax free, and the other half is taxed at the marginal tax rate of the vendor in the tax year of the disposition. The magnitude of impending tax effect from capital gains is a moving target, because market values change, and because owners spend money upgrading their properties. For owners who live year-round in their "resort" home, and that is their only piece of real estate, they needn't concern themselves with the capital gains tax so much. This is because their cottage is also their principal residence, and as such there will be no capital gains tax on it at the death of the last spouse. One point of temporary tax relief for dual-property owners is called the "principal residence exemption" (PRE). When the first of the two properties is disposed of in one of the ways listed above, the owner(s) have the choice to designate on their tax return which of the properties has been their principal residence up to that date. Up to 1982, spouses could each designate one property as long as one was the legal owner of one property and the other owned the second property. But since then, they must both choose one or the other. The PRE tax clause means that deferral of tax can take place until the sale of the second property. I would advise dual-property owners to talk to their tax professionals about how this can work to their advantage. Because of the PRE tax deferral option, it is important for dual-property owners to keep records (purchase documents, receipts for capital upgrades, and receipts for costs associated with selling or transferring, etc.) to support ACB calculations on BOTH the home and the cottage. The value of owners' labour may NOT be included as part of the ACB. However, another liability connected to owning real estate is that there can be provincial probate fees payable on the fair market value of the property at the time of death of a sole, or surviving joint, owner. These are very high in Ontario, B.C., (and grade to a high level in Nova Scotia), but fairly insignificant, comparatively speaking, in the other areas of Canada. It is important for owners to quantify this possible liability while updating their plans for cottage succession. Lawyers, accountants and financial planners can advise cottage owners of the pros and cons of various strategies that can be used to eliminate probate fees. For example, the possible downside of adding adult kids' names to the cottage title to defer probate fees to the next generation is that the asset is then subjected to kids' creditors, and possibly even estranged spouses' claims, unless the legal documents are very carefully drafted. While the Living Will (as authorized under the various provincial laws) has legal force in most provinces, remember that your wishes can be challenged by family members or even the office of the public guardian in your province. Actions that can be construed as assisting suicide or euthanasia are not permitted under Living Wills. In some instances, doctors are reluctant to abandon extraordinary measures to keep patients alive because they fear legal action from disgruntled family members. Watch for Part 2 of this article for alternative ways of effectively handling cottage transfer.