Is it true that if your parents sell you the cottage and hold a demand mortgage, they will not be subject to capital gains, and if they forgive the mortgage to you when they die you will not be subject to inheritance tax?
—Tammy Coady, via e-mail
First, let’s clarify: In Canada, we don’t have inheritance tax. You may be thinking of a probate fee, which applies to assets that are dealt with in a will that is probated. (It wouldn’t apply here, since the cottage is being sold before the owner dies.) Or you may be thinking of the US, which has an estate tax, payable upon death. So add “No inheritance tax, hot dang!” to the list of reasons why it’s great to be Canadian, and stop worrying.
Unfortunately—we’ve said it before, and we’ll say it again— there is no strategy that will eliminate the capital gains tax completely when handing down the cottage to the kids (whether it’s gifted or sold, during the owner’s lifetime or upon death). But the game plan you’re describing—your parents sell you the cottage and hold a demand mortgage with deferred payments—may be a good one for reducing it. (“Demand” means it’s a lump sum loan, payable on demand; in this case, the terms of repayment would specify that it be “not receivable for five years,” the maximum.)
“There are two advantages to this arrangement,” says Karen Slezak, a tax partner with Crowe Soberman LLP in Toronto. “First, the parents can spread the capital gain to be reported over five taxation years. Every year, they would report 20 per cent of the gain on their personal tax return. Second, because the amount to be reported each year is smaller, the gain may be subject to a tax at a lower marginal tax rate.” So, sorry, Mom and Dad, this doesn’t avoid taxation. But at least the impact is spread over several years. (If the parents sell the cottage to the child without holding a mortgage, all of the capital gain is taxable in the year of sale.)
In their will, your parents can “forgive” the mortgage. And, we sincerely hope, anything else that needs to be forgiven.