The family cottage has become one of the most contentious assets in estate planning and litigation, probably as a result of the emotional bonds that are attached to it. Commonly, cottage owners wish to ensure that the cottage will be available for enjoyment by future generations. Formulating an effective succession plan entails overcoming a number of issues. What follows is a brief overview of these issues.
Determining the Successors
Without a cottage succession plan in place, ownership may go to all children equally, and the result is almost always conflict. As unpleasant as it may be to discuss what will happen to the cottage when you are no longer around, it could very well avoid litigation between your children. Most heirs will want to continue to use the cottage, but the real question is who will take on the responsibility of maintaining the property. Some factors your heirs should consider are their wealth, the costs of ownership, their proximity to the cottage, their spouses, and time. Honestly evaluating your heirs’ interest in the cottage may be a reality check, the expense of owning a cottage was not part of your children’s cottage experience. Determining who wants to take on the responsibility of the cottage before your death can ensure an appropriate plan is in place that satisfies everyone’s interests and avoids future litigation. It may be that keeping the cottage in the family is not a feasible option.
Capital Gains Tax
The biggest issue in cottage succession planning is the capital gains tax. A capital gain is triggered whenever a property is sold, or deemed to be sold (such as the death of the owner). The cottage, often having been purchased decades ago, will likely attract a substantial capital gains obligation. One method of minimizing the burden of capital gains is the principal residence exemption. Most cottage owners have a house and a cottage. If the value of the cottage has increased more than the house, it may be worthwhile to apply the exemption to the cottage property.
Capital gains payable by future generations can be addressed by transferring the cottage to a trust or corporation. Another method of dealing with capital gains is to purchase life insurance to cover this amount on your death. Alternatively, the value of a property can be reduced by designating the property as a nature conservancy thereby reducing the capital gains payable; however there are serious implications to this designation that will bind the property perpetually.
The reality is that tax will be payable in one way or another, and there is no way to avoid capital gains. It is a myth that one can “gift” a property to their children to avoid capital gains. The gift may avoid probate fees, but the CRA may show up one day to collect the capital gains tax, plus interest and penalties.
Determining how the successors will own the cottage is another important issue. In most cases direct ownership will be the best option. In some cases, it may be advantageous to have the cottage held in trust or owned by a separate corporation. Additionally, under any of the above ownership formats, a fractional ownership or timesharing arrangement may be useful where it is unlikely the successors will share and use the cottage equally.
Irrespective of how ownership is structured, a well drafted shared-ownership agreement is an indispensable component where more than one individual will own a cottage. Such an agreement should contemplate the following:
Management and decision making;
A usage schedule;
Operating and maintenance costs, including non-monetary contributions;
Renting the cottage; and
Buy-out provisions, including a formula for determining market value.
The cottage succession process presents a number of challenges that require careful planning and attention. The services of an accountant, lawyer and financial planner should seriously be considered. No matter what succession route you choose, it is important that your wishes be expressed in your Will and Power of attorney.