Succession Planning

Cottage goers enjoy the Muskoka area of Ontario.
(Kevin Van Paassen/Kevin Van Paassen/THE GLOBE AND)+

Personal Finance

Handing down the family cottage

Many parents want to pass the family cottage down to their kids and grandkids. Increased demand and dwindling supply have led to massive leaps in recreational property prices, making it less likely the kids will ever be able to afford one of their own.

More Related to this Story

  • Tax MattersPassing along the keys to the family cottage

  • Sacrificing a home for income's sake

  • Tax MattersHow your home can help you save on taxes

The trick, says Peter Lillico, a lawyer in Peterborough, Ont. who specializes in cottage succession planning, is figuring out how to do it without bankrupting the kids. Experts agree that the most important financial issue is how to minimize the tax hit.

Join lawyer Peter Lillico in a live discussion on inherting a cottage at noon (ET) on Tuesday, June 2nd

In Canada, any change in cottage ownership - either after the parents' death or during their lifetime - will be seen as a transfer at fair market value and trigger a capital gains tax. The final tax bill can often run into tens of thousands of dollars and unintentionally force the kids to sell the cottage.

Mr. Lillico need to come up with a plan in order to leave behind a legacy of love, and not one of financial and emotional frustration.

"This can work but the chances of that quadruple if the parents actually have a plan other than just dying and leaving it in their will to be split equally among the three kids, whom they assume will get along," he said. "The cottage is not like other assets because it has so much emotional significance."

Peter Lillico's six steps to ensure a seamless cottage succession:

  1. Estimate the capital gains tax due upon transfer
  2. Take action to reduce the tax bite
  3. Fund the capital gains tax liability
  4. Select your preferred plan
  5. Prepare agreements to avoid adversity
  6. Level the financial playing field

One way to minimize the capital gains tax bill is to designate the cottage as your principal residence, as opposed to the house. If the cottage is the principal residence, the sale of it will be free of capital gains tax. Another strategy is to transfer ownership in stages over a period of five or 10 years, so that the taxes owed in each year will be lower.

Since the capital gains tax liability increases with each passing year, there is motivation to transfer during the parents' lifetime at a lower cost.

However, if parents decide they can't afford it and wait to transfer ownership until after they die, they could opt to use the proceeds from the sale of their primary residence to cover the capital gains tax. Sometimes parents decide to establish a trust - a situation where money is invested and administered by the executor to be used solely for cottage purposes.

Scotia McLeod wealth adviser Andrew Pyle said many of his clients choose to take out a life insurance policy that will kick in when they die and cover the projected onerous tax bill. Sometimes the kids share in the financial burden by paying the insurance premiums for their parents.

He expects will become more and more vital in the coming decade.

"Cottages that were bought for a song 30 years ago are now being passing down generations as valuable properties. Given the Canadian demographics, this will only become a bigger issue," Mr. Pyle said.

Sheila Crummey, a lawyer in the trusts, estates and succession planning group at McMillan LLP in Toronto, says a common mistake she sees is parents drawing up wills that don't include provisions of what should happen in the event their child dies before they do. "So the cottage goes to one sibling, and the children of the deceased sibling end up losing out."

In the majority of cases, she says co-owning a recreational property with siblings or other family members simply does not work. "I often discourage clients from sharing things like a cottage," Ms. Crummey said.

When parents have the blinkers of love on, they want the kids to inherit the cottage equally. That could lead to feelings of resentment, guilt and strife.Lawyer Peter Lillico

Mr. Lillico said that although parents might want to will the cottage equally to all three of their children, they need to step back and take a realistic view of which kids are in a position to use the cottage, or even want to. If one child lives in another country or is not financially able to contribute to their share of the annual bills, they could consider leaving that child off the cottage deed and compensating them in another way. They could, for instance, give them a cash sum from the sale of their house.

"When parents have the blinkers of love on, they want the kids to inherit the cottage equally," he said. "The reality is that for some kids a cottage will be a financial burden. That could lead to feelings of resentment, guilt and strife."

Finally, if there is any chance that the remaining siblings are going to be able to successfully share the property, the family will need a cottage agreement, Mr. Lillico said. A cottage co-ownership agreement is a basically a legal document that covers things like: Who will open and close the cottage? How will the bills be paid? Who get to use the cottage and when?

Once those issues are ironed out and everyone is on board, there is a chance that the cherished cottage will stay in the family for more than the six months it takes to list and sell it after the parents die.

"Everybody has the same issue and dynamics, and the difference between success and failure often is how creative your advisers are," Mr. Lillico said.

Roma Luciw is a writer and web editor of the personal finance site. Please send any comments and story ideas

There are no comments

Thank you! Your comment has been submitted and is awaiting approval.

Michael Dickinson

Michael Dickinson

CENTURY 21 United Realty Inc., Brokerage*
Contact Me