Dealing with the Family Cottage

by Rob Lewis

I wish more of my clients would ask this question, because few people seem to understand that passing on a cottage to the children or grandchildren is not as straightforward as simply including it in their will. There are a few things to consider, such as taxes.

Unfortunately, taxes are as much a part of being Canadian as spending time at the cottage. While land transfer tax does not apply to gifts of real property to family members, capital gains tax does apply. Without proper planning, whoever inherits the cottage could face a hefty tax bill. I’ve seen cases where the cottage had to be sold just to pay the capital gains tax, defeating the good intentions and wishes of the deceased.

Most family cottages are worth a lot more today than they were originally. When you transfer ownership, capital gains tax is due on the difference between the original purchase price plus the cost of any improvements and the cottage’s current market value. Let’s say the grandparents made no improvements to the the cottage they bought in 1960 for $25,000, and it’s now worth ten times than amount. Transferring the cottage would incur tens of thousands of dollars in capital-gains tax. If there’s not enough money in the estate to cover the tax bill, then whoever inherits the cottage would have to pay it if they choose to accept the gift of the cottage. Otherwise, the cottage may have to be sold in order to pay the tax.

There are several ways to deal with this problem. A common approach is for the owners to buy a life-insurance policy that would pay out enough of a benefit to cover the capital gains tax. In some cases, the children even pay the insurance premiums.

Another option is to transfer ownership now, before the cottage’s value increases any further, and while everyone’s financial and tax circumstances are clear. Under the second option, it’s a good idea for the original owners to require the future owners to enter into a joint use and ownership agreement.

The agreement would guarantee the original owners access to the cottage for the rest of their lives. A joint-use agreement also helps to avoid potential conflicts not unusual when a cottage has been in the family for more than a generation or two. This type of agreement typically lists everyone’s rights, roles and responsibilities (e.g. repairs, property taxes and maintenance), and spells out how disputes will be resolved. A good joint-use agreement will also explain how one party can buyout another party.

Two other options transferring the cottage to a corporation or to a family trust offer more complete, but more complex solutions. Deciding which option is best for you depends on the circumstances of everyone involved. Our firm has helped many clients create and implement plans to keep the cottage in the family for generations to come. While each client has unique needs and concerns, they all agree that the cost of legal advice to set up an orderly transition easily paid for itself many times over. Ultimately, everyone wants cottage time to be carefree and relaxing. Careful planning helps achieve this goal.

Rob Lewis is a local lawyer and long-time Canterbury and South Ottawa volunteer.