The family cottage is often the source of years of happy memories: children with sand between their toes; campfires; boating and large family gatherings. Because clients and their children can be emotionally tied to a family cottage, options for transferring it to the next generation should be thoughtfully considered.
Communication is Key
This may be an opportune time for a family meeting. A frank discussion may confirm who is interested in acquiring the property, how much control the clients want to maintain over it, who can afford it, whether insurance should be purchased to offset costs, and how to arrange ongoing maintenance. You may advise that your clients’ children and spouses sign a contract excluding the cottage from any family law claims. A timely, open family discussion might be the best way to allow for proper planning and to avoid unpleasant conflict.
A Fair Approach
As much as your clients may want all of their children to enjoy the cottage, you should remind your clients that their children may have different salaries, different family situations and perhaps different countries of residence. Fair treatment may not necessarily mean an equal share in the cottage property. An approach that respects each child’s specific situation and treats them fairly – but not the same – may be a better solution.
Some options include:
1. Sell the cottage
Your clients may want to sell the cottage to their children. The sale proceeds will provide funds to cover the capital gains tax triggered by the disposition, provide retirement funds for the clients, and avoid estate administration taxes on that asset. The downside is the potential for sibling discord. The child who is passionate about the property but cannot afford it may resent the sibling who has the means to make the purchase.2
2. Gift the cottage
Your clients may choose to gift the cottage to their children. This, too, avoids estate administration taxes and provides the kids with title to the property at no cost. However, the transfer triggers a disposition at fair market value, possibly resulting in a taxable capital gain to your clients. From the children’s perspective, their tax cost will be the fair market value at transfer.
The benefits of gifting are obvious; however, there are potential pitfalls. Some of the children may not be able to afford the upkeep and maintenance of the property; they may have different financial priorities; or they may be located at an inconvenient distance from the property. Any of these situations could plant a seed of sibling discontent.
3. Settle an inter vivos cottage Trust
You may advise your clients to transfer the cottage into an inter vivos trust for the benefit of future generations. This transfer will be a disposition at fair market value, with capital gains tax implications for the transferor. However, the trust can include instructions for the maintenance of the property and set out its treatment on the death of the beneficiaries.
4. Create a testamentary trust
Another option is to create a testamentary trust through your clients’ Will. On the date of death, there will be a deemed disposition at fair market value, with potential capital gains tax implications to the estate. However, as above, the trust can set out guidelines for the maintenance of the property and can establish a fund to offset some of the expenses.
5. Incorporate a not-for-profit corporation
The clients may wish to transfer the family cottage into a not-for-profit corporation. Although the initial transfer will trigger a deemed disposition at fair market value, future generations of cottage users will be able to avoid capital gains and estate administration taxes on the property. As with any NFP corporation, there must be a board of directors, organizational bylaws, rules relating to membership and operational issues, and an annual CRA filing.
A word of caution: CRA may not look favourably on this use of an NFP corporation and, in some circumstances, may consider use of the property to constitute a taxable section 15(1) shareholder benefit.
Family Management Agreement
No matter how the cottage is transferred to the next generation, a management agreement governing use of the cottage may be the best way to avoid future conflict. A thorough agreement will include:
- an annual budget;
- a schedule of detailed financial contributions;
- the allocation of responsibilities;
- a workable schedule of use of the property;
- a framework for decision-making; and
- a framework for the eventual sale of the property.
You should advise your clients, and in this case their children, to obtain tax advice as they consider their options.
Although the family cottage can be a difficult topic to address, you should thoughtfully explore all options with your clients. In most cases, proper planning today will minimize the potential for conflict later.