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Cottage Planning

Cottages are similar to family farms. Their succession plans should be similar too. Cottage succession planners should take a lesson from farm experts. Cottages, like farms, make succession planning challenging. Succession planning for the family cottage has many similarities to transferring the family farm. The primary goals of most cottage owners are:

  1. To preserve the cottage for future generations
  2. To eventually transfer the cottage to those family members who want to use it or to all the family without creating family disputes
  3. To make the cottage affordable for the next generations
  4. To minimize Capital Gains Tax and probate fees while still maintaining control during their lifetime
  5. To treat all family members fairly (if not equally) in the division of their wealth
  6. To protect the cottage and their children from Family Property claims by spouses and common-law partners and from their children’s creditors.

A prime concern is often the rapid increase in value of cottages (or farms) such that the Capital Gains Tax and probate fees payable on death will be so significant that the cherished asset might have to be sold to pay the tax. The Income Tax Act deems you to have disposed of all your assets at death. A common solution for farm families is to create a sale to the next generation significantly before your death. The sale could be to some or all of your children, or to a family trust.

Selling sooner defers any future capital gains to the next generation, but most owners are not prepared to give up control of the property. Although they hope not to sell, they are not sure if they will need the proceeds from the sale of the cottage or farm prior to their death to support themselves in retirement.

The solution: to transfer now but maintain control and have access to the current market value of the asset. Sound too good to be true? Read on – who says you can’t have your cake and eat it too?

At law, the ownership of a property can be separated into the life interest and the remainder interest. A cottage owner can sell a remainder interest in the property at Fair Market Value to some or all of the next generation, keeping a life interest in the property until the survivor of the current owners dies. This method of ownership eliminates probate fees as it takes the cottage or farm out of the life tenant’s estate as the life interest is extinguished immediately on death, and the property automatically transfers to the remainder owners.

By continuing to own the life interest in the property, the current owners are entitled to the total use of the property during their lifetime. They are responsible for taxes, insurance, and normal maintenance. The remainder interest owners cannot interfere with your rights while you are alive, yet they receive the benefit of the increase in value after the date of transfer and have certainty that they will ultimately own the property outright. If you need more money, you can demand payment on the mortgage. Thus, you maintain your ownership rights and control while deferring future capital gain.

In many cases it may be advisable to sell sooner rather than later for three reasons:

  1. Nobody knows when they are going to die.
  2. Deferral – you are postponing tax on any future increase in value to the next generation now.
  3. You can take advantage of multiple principal residence exemptions, saving you more tax. You can only have one principal residence exemption at any one time between you and your spouse or common-law partner, but CRA gives you an additional year each time you use the principal residence exemption.

Which residence you declare as your principal residence matters, because the Principal Residence Exemption reduces or eliminates the capital gain on your home or cottage. Some people do not understand that they have the choice to pick the cottage or the house as their principal residence. The Income Tax Act is very clear that you can choose, provided that you use both. Choosing to use the Principal Residence Exemption earlier gives you a higher percentage of exemption on the second one, plus the additional year on each.

Each family situation is different.

We highly recommend a detailed agreement that sets the ground rules in advance of the transfer. Things this use agreement needs to consider are:

  1. What happens if one of your children passes away? Are they entitled to leave the property to their children or spouse or must the remaining children buy out the deceased child’s interest at the time of his or her death? Should they consider life insurance on each other?
  2. What happens if one of the children wants to sell during their lifetime? Are the other children required to buy out that child’s share? Are there restrictions on sale?
  3. What happens if major repairs are needed to the property? You may wish to have two categories of repairs – essential and non-essential. Essential repairs require all children to contribute equally to the cost. Non-essential repairs could require either a unanimous decision by the children or the majority. Some people leave a fund in their will for cottage repairs.
  4. Restrictions on use – telephone, motorboats, television, internet, sport utility vehicles, skidoo, etc.
  5. Entitlement to use – exclusive or otherwise, i.e. will each child be entitled to certain number of weeks per year of exclusive use? If so, how will the periods of use be chosen? If you have no exclusive occupancy periods or if you choose limited exclusive occupancy periods, how will use be arranged? What about inviting guests? Will children who are not taking title be entitled to use of the cottage?
  6. Expectations of each owner include rules for leaving the cottage at the end of a stay, such as cleanliness and how staples are replaced.
  7. You should also contemplate whether one or more of the children are likely to do more work at the property than the others (miscellaneous fixing and small construction projects, opening and closing the cottage, etc.).
  8. Some formula should be inserted in the use agreement for solving problems, by mediation or arbitration instead of court.

Drafting use agreements is not that different from drafting a shareholders’ agreement among shareholders in a corporation.

Most owners prefer to transfer property only to their children (not spouses) and to get Family Property Act waivers with independent legal advice signed by the spouses of the children they are transferring to.

Once the plan is implemented, you will need to revise your wills and ensure your children have wills and powers of attorney that dovetail with the use agreement.

It is important to consider these issues and get advice now, while you have your health and time to consider the options and discuss them with your family and advisers. The use agreement is best settled and signed before any transfer takes place. It’s amazing how much more cooperative children are when the parents are still alive and able to give their input. The agreement sets the rules, and it can always be changed if all parties agree.