Use an NPO to hold recreational property

When Larry and Brenda came into my office to discuss the problems they were having with the family’s recreational property in Muskoka, I sensed that they were looking for a new solution to an old problem and that I just might have one.

Larry was concerned that increased value of the property would bring increased tax liability on sale or death. Brenda was looking for the best method of structuring the ownership of the property, so that maintenance costs could be covered and family conflicts could be minimized.

Both sought assurance that on the transfer to their heirs there would be minimal cost in terms of tax and administration.

I suggested using a non-share capital, not-for-profit, corporation (NPO) to provide solutions to these problems.

The NPO provides the following benefits:

• avoiding a deemed disposition of the property on the death of any one family member or the making of a gift of the property to any family member;
• providing a framework for making decisions and continuing that authority for future generations;
• minimizing Canadian provincial probate duties and, where applicable, U.S. estate tax that would otherwise apply on the death of a family member or U.S. gift tax on a transfer of property from one generation to the next; and
• providing some creditor protection over an asset possessing both financial and emotional value.

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I reminded Larry and Brenda that on the death of each Canadian resident, he or she is deemed under the Income Tax Act (Canada) to have disposed of all property, including vacation properties, and to have realized proceeds of disposition equal to the then fair market value of such property.

To the extent the deemed proceeds exceed the adjusted cost base of the property, a capital gain will be deemed to have been realized. One-half of the capital gain will be included in the income of the taxpayer for the year of death, and be subject to ordinary, marginal rates of taxation. Similar rules apply in respect of a gift of property during one’s lifetime. Accordingly, capital gains tax may become payable on the transfer.

Furthermore, when their wills are probated, the value of the Muskoka property will be taken into account when the probate fee is calculated. If Larry and Brenda were to use a trust to hold the cottage, that trust would be deemed to have disposed of this property every 21 years for proceeds of disposition equal to the then fair market value. That gives rise to capital gains tax (at the highest individual marginal tax rate).

Larry was concerned the NPO would be taxed the same as any other corporation. I explained it will pay no tax on its income if:

• It’s organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit; and
• No part of the income of the NPO is available for the personal benefit of its members.

Brenda asked how the NPO could be structured to meet all their objectives and still retain the tax benefits. I explained that both Larry and Brenda as well as their children (when the parents decide it’s timely) may be the directors and members of the NPO. The NPO would act like a club and provide recreational services to its members in consideration for annual fees and rental payments for use throughout the year. These payments will be used to maintain the property.

In order to finance the purchase of the property by the NPO, I suggested the couple transfer the property to the NPO in return for a non-interest-bearing mortgage equal to the value of the property. This transfer would be taxable, and so I recommended they obtain a professional appraisal of the property’s fair market value to minimize risk of a future challenge from Revenue Canada that the transfer was made for inadequate consideration.

I recommended the NPO conduct regular meetings of its Board of Directors and annual meetings, at least, of its members, and that it documents its decisions. In addition, the NPO should keep proper books and accounting records with respect to all affairs of the club, including annual financial statements.

As each family member would have only a life interest as a member of the NPO, there would be no taxable benefit conferred upon such family member for the use of the corporate asset, as would likely happen in the case of a shareholder of a for-profit-corporation. In addition, when a family member dies, the life interest would merely expire, without the person being deemed to have realized capital gains.

If a child were to get into financial difficulty and a creditor seek to take possession of the child’s minority membership interest in the property, there would be little the creditor could do to affect the NPO or the other members.

Brenda was concerned that after their deaths the children might not wish to maintain the Muskoka property. What would happen then?

I explained that the NPO could sell the Muskoka property on a tax-free basis, and the proceeds could be used to acquire one or more other recreational properties on a tax-free basis.

Alternatively, the NPO could be wound up and the proceeds distributed to the members. First, there would be a return of capital to the owner of the non-interest-bearing mortgage on a tax-free basis. Second, the additional proceeds, if any, would produce capital gains in the hands of the members.

Lorne Saltman is a tax partner with the Toronto-based law firm Gardiner Roberts LLP.

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