The Family Cottage

What to consider in your succession plan for the Family cottage

Cottages often hold deep sentimental value for families, creating cherished memories across generations. Without a well-thought-out estate plan, family harmony could be jeopardized.

A comprehensive cottage succession strategy begins with a review of your wishes and an open family discussion. This ensures that everyone’s interest in the future use of the property is understood, and preferred arrangements are made. These arrangements may include setting aside funds, possibly through a Will, for future maintenance and property taxes, as well as establishing a fair method for sharing the property.

Family Conversation

Having a family discussion is always the first step to estate planning for a family cottage. Many succession plans concerning the family cottage end at this stage, where parents discover that no one in fact wishes to keep the cottage after their parents have passed. Alternatively, parents can learn whether one, some, or all their beneficiaries wish to keep the cottage, which can help to define the scope of the succession plan and available options.

Options for Transferring the Cottage

1. Direct gift to one or more child(ren)

   The simplest way to transfer the family cottage to the next generation is to gift it directly to the child or children who want to keep the cottage. This can be done during life or on death through a Will. When transferring the cottage directly to one or more children, there are some issues to consider:

   1. Type of ownership

      Two common title registrations are joint tenants with right of survivorship and tenants in common.¹ Joint tenants with right of survivorship ensure that an owner’s share automatically transfers to the surviving owners upon death, avoiding probate. This means the last surviving joint owner will have sole ownership, which might not reflect the parents’ original wishes.

      In contrast, Tenants in common allows each child or beneficiary to own an independent share, which passes to their named beneficiary(ies) upon death.

   2. Expense and cottage sharing

      If more than one child will own the cottage, it may be beneficial to have a plan for use of the cottage and how expenses are to be dealt with. Other important issues to incorporate into the agreement may include renovations, rental of the property, buyouts, and further transfers to the next generation.

   3. Equalization

      If not all children will have ownership of the cottage, a parent may wish to equalize this gift by gifting a sum of money to the non-owning children equal to the value of the cottage. It is important to ensure that the estate, net of taxes and fees, can support such an equalization. If there is a risk that the estate may not have sufficient funds or liquidity, other options such as life insurance can be considered.

2. Transfer the cottage to a family trust

   Trusts provide a robust solution for cottage succession, acting as separate entities for ownership and tax purposes. They can protect the property from creditors or former spouses/partners and defer certain tax triggers. Trusts can be established during one’s lifetime (inter vivos) or upon death by Will (testamentary).

   If the family cottage is transferred into a trust, the children can continue to have full use of the property, but the trust terms would set out how the cottage is to be managed and expenses covered. Funding the trust to cover property taxes, maintenance, and renovation costs is crucial. It is also important to understand and plan for the unique tax and legal requirements associated with administering trusts.

Transfer during life or after death?

Parents often wonder if it makes financial sense to gift the family cottage during their lifetime, as opposed to waiting until death. Transferring the cottage during life can avoid probate fees, as the cottage no longer forms part of the parent’s estate.² However, there are a number of considerations:

1. Loss of control

   Once a parent transfers their cottage to their children, they will lose all control and ownership interest in the property. This may not be ideal if the parent wants to keep using the property, or later realizes that they need access to the financial value of the property. As well, the cottage may become subject to marital or creditor claims made against a child who now has an ownership interest in the property.

   Transferring the cottage to a trust, instead of directly to the children, can alleviate many of these concerns. Another option is for the parent to transfer the property but to take back a “life interest”, which would entitle the parent to continue using the property during their lifetime.

2. Principal residence exemption

   The principal residence exemption allows an individual to avoid capital gains tax on real estate that is principally used as a family residence. Only one property can qualify for the principal residence exemption in any given year. If the parents are able to shelter the cottage property from capital gains under a principal residence exemption, this tax sheltering could be lost where the property is transferred to children or to a trust. Whether or not this is true will depend on the use of the property, the financial situation of the children, and whether a trust structure is used.

3. Capital gains

   Unless sheltered under the principal residence exemption, transferring the cottage to children or to a family trust may trigger significant capital gains tax. Parents may therefore not wish to transfer the property during their lifetime if they do not have the excess funds needed to cover this tax.

   Conversely, triggering these gains during the parent’s lifetime, as opposed to on death, may reduce the overall gains payable for two reasons. First, taxpayers are often at a lower marginal tax rate during their retirement years than in the year of their death. This is because, on death, a person is deemed to have disposed of all of their assets at one time, which often places the deceased in the highest marginal tax bracket in that year. Second, transferring the cottage during life “crystallises” the capital gains, so that any further appreciation of the cottage property between the time of the transfer and the time of the parent’s death are not realized at the time of death.

Conclusion

There are many options available for transferring the family cottage to the next generation, and each family’s situation is unique. As with any aspect of succession and estate planning, families should work with a professional estate planner to ensure that their specific plan works best for their needs and circumstances. For more information, and to learn about options available to you in planning your estate, reach out to your financial advisor.

 

 

 

Raymond James Ltd.’s trust services are offered by Solus Trust Company (“STC”). STC is an affiliate of Raymond James Ltd. and provides trust services across Canada. STC is not a Member of the Canadian Investor Protection Fund.