Life Insurance and Capital Gains Taxes
It is said that there are only two certainties in life; death and taxes. These often go hand in hand. While you may think you are done on this earth and debt no longer is an issue, the fact remains that you still need money even after you pass on.
The first step in estate planning is to create a will. It should be updated on a regular basis, just like your life insurance. Your executor will file your final tax return on your behalf. Some of the expenses that may show up include:
Capital gains taxes on a family cottage, holiday condo or even a rental investment property
Income taxes will still need to be paid
Probate fees may also be an expense
Here is where life insurance will help your family not only continue to live their lives financially solvent, but will help them pay the taxes and fees your estate may have accumulated.
Let’s take a look at capital gains taxes. A cottage would be a prime example of how capital gains taxes may accumulate. The simplest way to explain how this happens is through example:
A couple purchased a lake front property, with a cottage, in 1989. The value of the purchase at the time is $120,000. A few years later they start a family, and the first child is born in 1991, followed closely by another in 1992, and then a third in 1998. The cottage is their place to go and relax. In 2018, the father passes away unexpectedly. He leaves everything to his wife, and while it may be a lot to take over, there are benefits to passing property along to your spouse; no taxes need to be paid. The cottage is now in her name and she wants to amend her will to leave the beloved second home to the children.
This is where it gets tricky. To will a cottage to your children, rather than a spouse, regardless of the child’s age, means that an assessment must be done at the time of death. Meaning that when the mother dies, the cottage will be assessed to determine the value, and also, the capital gains taxes the child will owe on the house, and that must be paid before they can transfer ownership.
To calculate the capital gains on a cottage, a holiday condo, or even a rental property, you must take the recent assessment amount, deduct the original cost, as well as the cost to sell the property, and the taxes will be based on 50% of the increase.
In this family’s case, the original cost of the cottage was $120,000. The current evaluation is $1.1M. The increase in the value is $980,000. Therefore, the capital gains taxes will be based on half of that amount, $490,000, as this was a private sale. Based on 2019, the capital gains rate is 15% (if your income is over $78K). This would mean that before the children can inherit the cottage, they must pay $73,500.
This is where the importance of a life insurance policy comes into play. Insurance is a tax-free cash benefit that is received quickly after the death of a person. When we do an assessment of your financial needs, the amount that you need to leave behind becomes part of your estate planning.
The type of insurance you carry also helps your family. Having a term policy is a great way to ensure you have coverage for an amount of time. Having a universal life or a whole life policy will protect your family until you are 100 years of age. Regardless of the coverage you have, you need to do a financial needs analysis as part of your estate planning. Making sure you have what you need will ensure your family can continue to enjoy the cottage for generations to come.
