With summer officially here and with the Canada Day long weekend coming up, talk of cottage plans is all around; small talk in the elevator, catching up while in line for coffee and chatter throughout the change room at the gym in the mornings.
Whether you call it a cottage, chalet, camp or cabin, it’s your family’s special place to relax and enjoy the great outdoors. And for many families, it’s a place filled with happy memories that’s been in the family for generations, and will be for generations to come.
But keeping the cottage in the family from one generation to the next isn’t always as easy as it might seem. There are many issues to consider, including how the taxes will be paid and maybe even some unwanted family drama.
As with many of our life milestones, smart planning at the outset can make a significant difference in the long-run – after all, a solid wealth management plan helps us to plan for the expected and the unexpected.
As you may already know, when you pass along your cottage, you are also passing along a potentially large tax bill, which your beneficiaries may or may not be able to afford. Depending on their financial situation, your beneficiaries may be forced to sell the family cottage simply to cover the taxes or buy out other beneficiaries. There are two main types of tax to consider – capital gains taxes and probate taxes. My team has published an article entitled, ‘Keeping the family cottage in the family with insurance’ – the article reviews ways to reduce taxes (such as gifting the cottage ahead of time or covering the tax bill with an insurance policy) and also provides examples for calculating the capital gains tax along with a family cottage case study. Click here to request the full article but in the meantime, I’d like to share some valuable succession planning techniques that I received from my trusted partners at Bales Beall LLP in their summer newsletter. Each of these tactics come with advantages and drawbacks - the challenge is finding the one that works best for your family. Please do not substitute these ideas for legal advice.
(1) Direct that it be sold – While this may be the easiest way to manage any conflict after the cottage owner's death, it may create some emotional distress if the cottage holds sentimental value to the next generation.
(2) Leave it to only one child but equalize the value – What’s fair isn’t always even. The cottage can be left to one child and other assets of equal value can be left to the other children. The result of this is that each child ends up with assets of equal value, but not of equal nature.
(3) Leave it to all of the children as joint owners on the condition that they enter into a co-tenancy agreement – This technique is useful for families where all of the children have a connection to the cottage and a desire to continue to use it. The Will could specify that the children will receive the cottage on the condition that within a certain time period, they have entered into a co-tenancy agreement which deals with the usage of the cottage, including the payment of expenses, improvements, repairs, the sale of the interest of any of the beneficiaries and a dispute resolution mechanism. If the children fail to enter into such an agreement within the specified time, the cottage gets sold to a third party. This approach only works for families where there is a good relationship among children and they are all old enough to manage their respective interest.
(4) Allow your children to buy the cottage – If the cottage owner doesn't want all of his or her children to jointly own the cottage but also wants to give his or her children the option to purchase the cottage, the Will can direct that the Trustees obtain an appraisal of the fair market value of the cottage and then offer it to the children for sale at that price. The Will can specify the manner in which the children can bid for the cottage. This may create some conflict in the short term among children if there is more than one interested party, but it ultimately creates a process whereby the cottage can be transferred to the next generation in a fair and transparent manner.
(5) Put the cottage into a trust upon death – This is perhaps our least favorite option because a trust is deemed to have disposed of all of its assets every 21 years. Accordingly, 21 years after death, any increase in the value of the cottage will be subject to tax, without an actual sale to generate the funds to pay the tax. While there remains the option to transfer the cottage out of the trust before the end of 21 years on a tax free basis, this creates a problem if some of the beneficiaries at that time are not yet old enough to deal with their interest. Further, if the list of beneficiaries has expanded into the next generation, the problems associated with multiple owners using and managing the property continues to exist, perhaps to a greater degree. Finally, this technique may be costly from an estate administration perspective if the trustees of the trust are individuals other than those who are benefiting from its use.
We encourage all cottage owners to have open discussions with their intended beneficiaries before deciding how to deal with a cottage or other recreational property in their Will – it’s a much easier conversation to have with everyone around the table to avoid any assumptions or expectations that may arise later on.
Now you are in-the-know with Word on the Street.
Enjoy your first official summer weekend,
Investment & Wealth Advisor