How to keep the cottage in your family in Canada

By Kevin-Barry Henry, #1 Bestselling Author

My Family has a great old cottage that my mom and dad built, with the help of so many family and friends, back in the 70s. We love it and my father wants us to keep it in the family for generations, and so do we! So what happens when the time comes to transfer ownership of our family cottage?

Unfortunately, in Canada a cottage is not considered principal residence and will incur a capital gain that the estate and beneficiaries will have to consider. Luckily, there are options and we will dig into them here.

The family cottage often gets a special place in many people’s hearts, and with good reason. Memories were forged over many years, and the emotional ties that the family cottage creates often last a lifetime, and you would like it to last beyond a lifetime. But what will it cost to keep it in the family?

Let’s look at an example of what keeping a cottage in the family might look like. Say you bought or built your family cabin in the 70’s and paid $20,000 for it. That would have been somewhere in the oil crisis and interest rates were heading toward 19-21%! Seems like another lifetime ago. It’s now 40 years later and the cottage has done very well and is now worth $220,000. Go ahead and add a zero if it’s around Vancouver or in the Muskoka’s. Because your cottage is not your principle residence, it cannot be sheltered tax free. Will it to your heirs and it will trigger a tax event when you die.

Let’s further assume that beneficiaries want to keep the cottage and not sell it. What would the tax bill be in this example to keep something that is already yours?

Because you paid $20k for it and it is now worth $220k, the net gain or appreciation is $200k and the people at Revenue Canada will want their share. Because this is capital gain, and thus the best taxation scenario, you get to keep the first 50% of the gain tax free. That’s right, $200,000/2=$100,000. That’s your family’s to keep.
Once again, the problem then becomes the second 50%. It will be taxed at your marginal rate as we learned. In the last chapter, we assumed a low-ish rate of taxation. In this chapter, we will be a little more honest. Since this is your terminal or final return and all you own is being taxed at the same time, we will assume you are near the top bracket, or around 50% marginal tax rate.

The remaining $100,000 will be taxed at your highest rate (50%), so $100,000X50% is $50,000. So your estate will have to write a cheque for $50,000 to CRA just to keep the cottage that you already own, in the family. That doesn’t feel fair.

Life Insurance

Life insurance is by far the easiest and most cost effective solution to the tax bill. What if, in your infinite wisdom, you planned ahead and secured a small life insurance policy for $50,000 for a few dollars a month with instructions that the proceeds of the policy were to take care of the tax burden and the cottage was to remain in your family in perpetuity to be enjoyed by your family for years to come?
Or your kids can fight over wanting to keep it, sell it or both. Cottages can be very contentious issues when deciding family estates. A little planning and some life insurance can go a long way to help make the decisions a little easier because the tax bill will already have been paid.

Joint ownership

Many Canadians are now looking to joint ownership of their homes and cottages as means of efficiently transferring ownership of their property at death to their beneficiaries. This allows them to continue to enjoy all the ownership privileges, and gives them the ability to defer the capital gain on the property, if it is not the principal residence, and would therefore be exposed to capital gains.
The structure of the land ownership in Joint tenancy, or joint ownership involves two or more individuals who, together, own the land. In the event that one dies, the property transfers to the surviving party, through the right of survivorship and avoids probate.

Tenancy in common

Tenancy in common on the other hand, involves land ownership by two or more persons, but on death, the interest of the deceased tenant’s ownership transfers to heirs, and not the surviving tenant. Only the unity of possession applies to tenancy in common, so make sure you choose the option that suits you.
They are both useful tools, but I still suggest you make your wishes known in writing in your will, to make sure there is no debate. You can never have enough documentation, as long as the instructions are consistent. Don’t contradict a joint tenancy ownership situation by appointing another beneficiary for the asset in your will. It will likely end up before a judge, so be clear, and consistent.

There could be some potential drawbacks to joint tenancy, so just be aware of them. The asset could become exposed to an adult child’s vulnerabilities, or it could be used as collateral in a loan.
The biggest risk is that it exposes the asset to an adult child, who is the joint account holder along with you, to the possibility that they may eventually have an ex-spouse. That ex-spouse is entitled to make a claim on the property if the joint tenancy was set up before the divorce.

Joint ownership also could expose your property to your adult child’s personal and business creditors, in much the same way as the matrimonial claim we just talked about. So be aware, because ownership comes with responsibility.
You may have noticed that I wrote joint ownership will defer the capital gain a few paragraphs ago. If you did, you’re starting to get it! The capital gains tax will be due someday, and it will have to be paid. If you decide to transfer your present ownership of your property in joint ownership with your child or children, you will trigger immediate capital gains that need to be paid. From that day forward, the next capital gain would presumably be up to your child to figure out, long after you’re gone, unless the property is designated as their principal residence. If that is the case, they can use the principal residence exemption, and the property would not be subject to capital gains tax.
Joint tenancy is a good estate planning tool, but you need to be aware of the places it could be weak, and adjust your plan accordingly.

Gifting

Gifting is another opportunity to bypass probate. You simply give the cottage to your child, and they, not you, become the owners. The same warnings apply here for creditors and matrimonial challenges, but you would also have to calculate and pay the capital gains tax up to the day of the gift. Otherwise, this can be a smart estate planning tool when used properly.
Another idea you may want to think about would be selling your property to your children, but you take back a private mortgage. The mortgage could be forgiven at death in your will. If you do decide to go this route, you will again trigger a capital gain, at fair market value for your property – not what you sold it to your child for – and if you choose this route, the capital gain taxes can be paid to CRA over 5 years instead of one.
If you suspect the cottage could be a contentious issue for your children, then make sure to address that in your will. Include a tie-breaker provision regarding ownership, and it might be a good idea to set aside funds in a trust to make sure the regular maintenance and property taxes are taken care of.
Speaking of trusts, let’s take a look at how a trust might help your property transfers.

Trust

A trust is another tool you can consider when deciding how to manage intergenerational transfer of your estate. A trust can offer tremendous flexibility when it comes to controlling the future use of your property.
A trust is simply an arrangement where one or more people known as the trustees hold a legal title to property (the trust property) for the benefit of other people (the beneficiaries). The person who creates the trust and puts property into it is called the settlor. The settlor can also be a trustee.

You can set up a trust while you are alive which is called and inter vivos trust or living trust for those of you that have forgotten your Latin, like I have.

You can create a trust in your will, and that is called a testamentary trust. This type of trust can carry on for many years after your death and operating under your specific instructions. That can be a very powerful legacy!
A trust is a separate person for income tax purposes and must file its own tax return every year.

Since we are talking about your cottage in this article, let’s look at how a trust could help transfer your assets to the next generation.

A trust can be set up while you are alive and could provide several advantages such as:

You could make yourself a trustee, and therefore, you keep control of the property.

By getting the property out of your estate, you can reduce the probate fees.

If your estate was ever brought before a judge after you die, for whatever reason, the contents of the trust (your cottage, for example), would not be part of the discussion as it is outside of your estate.

When you set up the trust, you control the power of the other trustees, and you can strictly limit and define them while you are alive.

A trust cannot be challenged by matrimonial dissolution, as your child will not own the trust, but simply be a trustee. That means the angry ex can’t make a claim on the cottage.

I’m not trying to suggest that your daughter-in-law or son-in-law are not wonderful people, or that you don’t look forward to seeing them as often as you can. I’m just saying….. If you want to keep control of your family assets beyond a marriage breakdown, a trust might offer you the option to control your cottage no matter how your children may feel about their spouses.

A trust is great idea, but they definitely will require the help of an expert to set up. Creative and sophisticated provisions can allow for control of your estate, alive or not, and can be tailored to individual circumstances.

If you would like to find out more about how you can keep your cottage in your family for generations, you can reach out to me at kbh@kbhenry.ca or book a free call here: BOOK FREE CALL

With gratitude,

Kevin-Barry Henry

THIS ARTICLE IS PROVIDED AS A GENERAL SOURCE OF INFORMATION ONLY AND SHOULD NOT BE CONSIDERED TO BE PERSONAL INVESTMENT OR LEGAL ADVICE. READERS SHOULD CONSULT WITH THEIR FINANCIAL OR LEGAL ADVISOR TO ENSURE IT IS SUITABLE FOR THEIR CIRCUMSTANCES.