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Learning Centre

Cottage Issues (Part 2 of 2)

By: Julie Leefe, CFP

In Part 1 of this article, I pointed out that capital gains tax and probate fees can both apply on cottage transfer. Part 2 will discuss alternative ways that owners might handle the issues.

There are several ways of "freezing" the capital gains tax liability in parents' hands before death so that future appreciation in the market value accrues to the kids' (tax when the kids sell or die).

Owners may choose to:

1. Give the cottage to the kids, but have a legal life lease drawn up that will give the parents access as long as they are living, and can list certain other conditions. Pro: This strategy avoids probate fees on the cottage value upon death of last parent. Con: If the PRE is not available for all the years of ownership, Mom & Dad may have to pay tax on some or all of the gains in the year of transfer.
2. "Sell" to the children and take back a demand mortgage. While this strategy basically carries the same pro and con consequences as above, if properly planned the parents may spread the capital gain over five tax years, thereby reducing or deferring the impact. If desired, parents can forgive the mortgage in their Wills, thereby leaving the cottage to the children with no debt or additional taxes payable.
3. Transfer the property to an inter vivos trust. This works well if the kids are minors or if parents want to maintain more control.
4. Set up a non-profit corporation and transfer the cottage in. Some tax professionals feel this arrangement can work where there are many family members wanting access to the cottage, and many who ought to be contributing to its maintenance.

Caution: If parents are over 65, the capital gains income in the year of cottage transfer while alive may reduce tax credits such as the age credit, or their OAS entitlement for the following year. And, again, as in Part 1 of this topic, I must reiterate that putting a cottage in kids' names subjects it to claims of their creditors. Also, any legal documents that in effect gift the cottage to kids should declare that the ownership is for the kids alone and not spouses or future spouses. This will help to ensure that if there is a marriage breakdown, the kids' ex-spouses will not have a marital property claim against the asset.

If the cottage is NOT transferred to the kids while the parents are still living, then capital gains taxes and probate fees will apply upon death of the owner(s). Much thought should be given to updating the owners' Wills and to wording them effectively. Parents know their children well and if they are honest with themselves plan well, they can forestall possible cottage issues after they're gone.

1. Do parents want to demand that it be sold, giving the children rights of first refusal to buy it?
2. Do parents simply want to leave it to the children without stipulating how they work out the details? While this is the easiest for parents, it can cause the most friction amongst the beneficiaries, as they try to work out an equitable arrangement for maintenance and usage. Also, the capital gains tax must be paid using dollars from other assets of the estate, or by the children funding it themselves.
3. 3. Parents may choose to leave the cottage in trust for the children in their Wills, which would enable them to name a trustee and list some conditions of the trust (control beyond the grave).

Where there is a desire to keep the cottage in the family, an effective way of generating the funds to pay the capital gains taxes on disposition can be having life insurance payable on the death of the owners. Either the parents or the beneficiaries can pay the premiums on the policy. This may be appropriate if the parents are healthy and insurable at standard rates, and if there's a possibility that there may NOT be enough other dollars in the estate to cover the capital gains taxes.

Cottage property values continue to increase. In addition to the tangible value is the intangible value…the R&R and family memories that the property affords. Emotion runs high in many families when the cottage is discussed. Sometimes none of the kids want it when the parents pass on, sometimes only one wants it, or two, and one doesn't. If one child out of three is to inherit it, then are there enough other assets in the estate to give the other two equal value? Might the parents want to buy enough life insurance on themselves to ensure equal value, or can the child who wants to keep the cottage afford to buy out the other siblings' shares? Should Mom and Dad pass it on to the child who wants it, before they die? It is important to have family discussions on this topic, and plan ahead. All options should be considered and the best family plan put into place, including an update of Mom's and Dad's Wills if needed.

These articles have not been written to comprehensively cover the topic. Readers would be well advised to confer with their lawyers, tax professionals and financial planners in planning for cottage succession.