The lake, the loons, the lazy hazy days. Nothing conjures up memories of summer bliss like the cottage. So it's not hard to see how trying to find a fair way to hand down the keys to this cherished asset could trigger a nasty family feud.
Many parents want to pass the family cottage down to their kids and grandkids. Increased demand and dwindling supply have led to massive leaps in recreational property prices, making it less likely the kids will ever be able to afford one of their own.
The trick, says Peter Lillico, a lawyer in Peterborough, Ont. who specializes in cottage succession planning, is figuring out how to do it without bankrupting the kids. Experts agree that the most important financial issue is how to minimize the tax hit.
Join lawyer Peter Lillico in a live discussion on inherting a cottage at noon (ET) on Tuesday, June 2nd
In Canada, any change in cottage ownership – either after the parents' death or during their lifetime – will be seen as a transfer at fair market value and trigger a capital gains tax. The final tax bill can often run into tens of thousands of dollars and unintentionally force the kids to sell the cottage.
Mr. Lillico says it's up to the parents need to come up with a plan in order to leave behind a legacy of love, and not one of financial and emotional frustration.
“This can work but the chances of that quadruple if the parents actually have a plan other than just dying and leaving it in their will to be split equally among the three kids, whom they assume will get along,” he said. “The cottage is not like other assets because it has so much emotional significance.”
| Peter Lillico's six steps to ensure a seamless cottage succession: |
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One way to minimize the capital gains tax bill is to designate the cottage as your principal residence, as opposed to the house. If the cottage is the principal residence, the sale of it will be free of capital gains tax. Another strategy is to transfer ownership in stages over a period of five or 10 years, so that the taxes owed in each year will be lower.
Since the capital gains tax liability increases with each passing year, there is motivation to transfer during the parents' lifetime at a lower cost.
However, if parents decide they can't afford it and wait to transfer ownership until after they die, they could opt to use the proceeds from the sale of their primary residence to cover the capital gains tax. Sometimes parents decide to establish a trust – a situation where money is invested and administered by the executor to be used solely for cottage purposes.
Scotia McLeod wealth adviser Andrew Pyle said many of his clients choose to take out a life insurance policy that will kick in when they die and cover the projected onerous tax bill. Sometimes the kids share in the financial burden by paying the insurance premiums for their parents.
He expects cottage succession planning will become more and more vital in the coming decade.
“Cottages that were bought for a song 30 years ago are now being passing down generations as valuable properties. Given the Canadian demographics, this will only become a bigger issue,” Mr. Pyle said.
