Cottage Succession

Handing down the cottage is a financial and emotional minefield. What you need to know to keep your funds and family intact.

By Ann Walmsley

Grandfather and kid on dockA decade ago, my father asked my three brothers and me to come up with a plan for passing ownership of our 1930s Lake Ontario family cottage in Prince Edward County from him to us. Sadly, he was spending less time there and wanted us to articulate our vision for its future. At that time, we were all in our 30s, all living in Ontario and negotiating successfully with each other for time at the two-bedroom cottage so that our 11 children could play on the mile-long white sand beach and its dunes just as we did when we were young in the 1950s and ’60s. Because there are only six beds, we informally worked out a schedule in the spring giving each family at least two weeks of exclusive time. We talked vaguely about trusts, family corporations, severing lots, and building ambitious additions. But that’s where the process stalled.

That’s where my soul is. I don’t want anything to mess with my connection with the place, but I want to preserve it for my kids and for us all.

Since then, our lives evolved and the decisions became even tougher. I moved to Texas, which meant that my family’s cottage use dropped dramatically, and slid even more when my two teenage children got summer jobs in Dallas. My mother bought a meadow backlot near the cottage on which one or more of us could build another cottage, but our spouses are not sure they want to build away from the water. My husband, for example, surfs the web frequently looking at cottage properties in Nova Scotia with wild coastline. We siblings started making sporadic financial contributions to the annual cottage operating costs and repair projects. But everyone has different ideas about how to make the cottage work for us and our children – even about whether or not to remove the cedar tree that fell along the front cliff a few years ago, its gnarled roots obscuring the view of the beach. My brothers and I know one thing: We would never want to lose access to the crashing body-surfing waves, the fossil-filled limestone cliff, and the warm, soft sand. As my youngest brother, Ben, said: “I have a recurring dream about the cottage in which it’s August and there’s hardly anyone on the beach and it's hot and windy and I’m sheltered behind a dune and I know that it’s windy in front of the dune. That’s where my soul is. I don’t want anything to mess with my connection with the place, but I want to preserve it for my kids and for us all.”

Naturally, I had read all the previous Cottage Life stories on succession planning for the family cottage. But it seemed as though my family still needed a “decision tree” to guide us through the choices sequentially, and some case studies to envision how various scenarios might actually work. The financial issues have become more complicated following the demise of the $100,000 lifetime capital gains exemption in 1994. The exemption helped to mute the tax consequences of the skyrocketing cottage property values that economist David Foot so aptly predicted in his best-selling book Boom Bust & Echo. Although cottagers tend to feel that passing down the cottage from one generation to the next is a non-taxable event akin to next-generation loons nesting at the same spot on the shoreline, now it is much harder to avoid the fact that the government will tax any deemed profit on the cottage as a capital gain, regardless of whether you sell it to strangers or give it to the kids. But other changes to the tax law have also generated some new considerations and options for cottagers.

One welcome development is that since October 2000 only 50 per cent of any increase in the value of the cottage has been subject to tax upon transfer – down from 75 per cent. Another key change as of June 30, 2001 is the introduction of alter ego trusts, a type of inter vivos, or living, trust that is created during your lifetime (see Create a Living Trust).

In hunting for some model case studies, I found, along the way, examples of families who had planned brilliantly, as well as those who just bumbled along and possibly owed plenty of back taxes to the government. One Toronto woman discovered when her father died that the cottage deed was still registered in her grandfather’s name, even though he had died years earlier. One man told me he had just “signed it over to the kids” and would not have to pay taxes until it was sold out of the family. Keep in mind that families who just add children’s names to the deed without paying capital gains tax will find that Revenue Canada may impose harsh financial penalties for skirting the law in addition to requiring payment of the back taxes owed. “The penalty may be as much as the taxes you neglected to pay, plus interest,” says David Street, a lawyer who does estate planning with the firm of McDonald & Hayden in Toronto.

Then I came across families who have already experienced the heartache of seeing a long-held family cottage slip away. A family that summered for years in the Bala area lost its remarkable cruciform-shaped 1880s cottage when one of the two cousins who inherited it fell victim to gambling debts. Another family in Muskoka found themselves disenfranchised because their great-uncle persuaded their grandmother to leave the property to her daughter and him in joint tenancy, rather than tenancy in common. When the daughter unexpectedly pre-deceased the great-uncle, the property reverted to him, cutting off her children. In joint tenancy, when one owner dies, his or her share of the property rolls over to the other owner. Most lawyers recommend tenancy in common, through which the cottage becomes part of the co-owner’s estate and is given to whomever is designated in the will. Some families may select joint tenancy because it is a simple way to avoid paying probate fees but, as accountants point out, probate fees are a better option than losing the cottage.

 

Continued...

Estate-planning laywer Peter Lillico's six-point plan

 

April/May 2002 coverExcerpted from How To Succeed At Succession by Ann Walmsley in the April/May 2002 issue of Cottage Life magazine.

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