For many families, cottages are a prized second home, holding sentimental value after a lifetime of special moments and great memories.
However, when the time comes to pass on the family cottage to the next generation, doing so without a succession plan to deal with questions and conflicts that may arise can be emotionally and financially challenging.
While many individuals tend to first focus on financial matters like tax considerations, an effective cottage succession plan addresses financial as well as emotional issues.
Who should the property go to?
The best solution may not always be the standard default of leaving the cottage equally to all children. After all, they may not have the same interest in the property or the ability (due to distance or cost considerations) to enjoy and maintain it. As such, a “cottage conversation” involving all stakeholders is often a great place to start.
Parents are encouraged to ask their children whether they want to take over the cottage and, if so, how best to transition it to them. Where an unequal transfer of the cottage is envisioned, it may make sense to consider other means of balancing or equalizing the overall transfer of estate assets.
Tax considerations
Unless the principal residence exemption is available, capital gains tax will apply when the cottage is sold or otherwise transferred to the next generation. This tax applies to the difference between the adjusted cost base (ACB) of the cottage and its fair market value at the time of transfer or sale.
The ACB may be the purchase price of the cottage or the value as of a different date (for example, 1972 when the capital gains tax was introduced, or 1982 when it was no longer possible for a couple to designate more than one property as a principal residence). If capital improvements have been made to the cottage (and can be supported by documentation), these costs may be added to the ACB, reducing the capital gain.
Can life insurance be used?
Life insurance can be a cost-effective method of providing cash to pay capital gains tax payable on death. Insurance may be purchased on the single owner of the cottage or, as is more often the case, on the joint owners.
A “joint last to die” policy, payable on the death of the survivor of parents, will cost less than either parent could buy individually. Insurance proceeds are received tax-free, whether payable to the estate or a designated beneficiary.
Depending on the situation, the children (who are usually the ultimate beneficiaries of the cottage) may be in the best position to pay the insurance premiums. Life insurance may also offer a solution where the estate plan calls for the transfer of the cottage to one child and an “equalization payment” to another. Obviously, this solution won’t work where the parents’ health precludes them from qualifying for life insurance.
Transfer to a trust
Where the decision has been made to transfer the cottage to the next generation, consider transferring the property to an inter-vivos trust. A transfer to a trust offers a number of potential benefits.
A discretionary trust can be useful where the ultimate beneficiaries of the cottage haven’t yet been determined. A trust can help ensure the cottage is enjoyed by the children and ultimately passes to the grandchildren (if any). A trust may also offer some protection against future creditors or matrimonial claims. Because the transfer generally triggers the realization of capital gains, this option usually makes sense only where there is a small gain or even a loss.
Going forward, taxes on any increase in value will be the responsibility of the next generation. It’s also worth remembering that the “21-year rule” may need to be considered as trusts’ properties are deemed to be disposed of every 21 years and will realize accrued gains at that time.
Trust arrangements can be complex, so it’s important to obtain proper advice and understand all the intricacies before taking this step.
Transfer into joint tenancy
It might be tempting to transfer the cottage into a joint tenancy with the children in an effort to reduce probate fees. While this may allow the property to be transferred outside of the Will by “rights of survivorship,” there are potential pitfalls.
Be aware that such a transfer will trigger the realization of capital gains. Moreover, this approach could expose the property to creditor or matrimonial claims that may be brought against any of the owners (note, this option is not available in Quebec).
A cottage can be a source of great enjoyment for the entire family.
Taking the time to develop an effective transfer plan — one that addresses emotional as well as tax and other financial issues — may prevent conflicts down the road, providing everyone with invaluable peace of mind.
The process of finding a financial advisor can be overwhelming. It is our job to make that process simpler and easier.
Dri Financial Group’s proprietary Wealth Navigator Process is designed with you in mind.
Its structured framework helps you make an informed decision and feel confident in our team and management practices before we get started.
We offer you a range of services from creating bespoke financial plans and providing investment advice to helping you take advantage of our investment models. If you would like more information on the Wealth Navigator Process or our team, call me any time at 416.355.6370 or email me at richard.dri@scotiawealth.com.
—
Beyond helping you manage your finances, we take pride in motivating, educating and helping you expand your financial literacy. We are here to answer any questions you have and to help you feel in control of your financial destiny.
If you are ready to dive deeper into your financial literacy journey, we have a wide range of free tools and educational resources available.
- Subscribe to our Never Retire Newsletter
- Contact us to order a complimentary e-book
- Check-out our latest Wealth Navigator Podcast
- Follow me on LinkedIn
source https://richarddri.ca/keeping-the-cottage-in-the-family/
Dri Financial Group 