Peter Lillico has been practising law for more than three decades. He describes his hometown of Peterborough, Ontario, as the "heart of cottage country" so it's no surprise that one of his specialties is cottage succession planning. Mr. Lillico, of Lillico Bazuk Kent Galloway, also focuses on trusts, wills, estate planning and estate administration.
Finding a way to is tricky, in part because it is such an emotional asset, Mr. Lillico said. In addition to the complex tax issues, a cottage agreement is an essential step in the planning process.
"The parents need to try to create a legacy of love, and not just hand over a hot potato," he said. ""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."
Peter writes regularly on various legal topics for several publications, including Cottage Life and Good Times magazines. He has developed and teaches law courses at Trent University, St. Clair College and Sir Sandford Fleming College, and frequently presents seminars on estate planning. His first book, on estate planning for small business owners, is slated to be published this year.
In his spare time he is a licensed display fireworks supervisor and solemnizes marriages as a Humanist Officiant.
Editor's Note : globeandmail.com editors will read and allow or reject each question/comment. Comments/questions may be edited for length or clarity. HTML is not allowed. We will not publish questions/comments that include personal attacks on participants in these discussions, that make false or unsubstantiated allegations, that purport to quote people or reports where the purported quote or fact cannot be easily verified, or questions/comments that include vulgar language or libellous statements. Preference will be given to readers who submit questions/comments using their full name and home town, rather than a pseudonym.
Roma Luciw, Globe Investor: Hi Peter. Thanks for joining us. Judging by the amount of questions pouring in, this certainly seems to be a hot topic - and an emotional one - among our readers. Lets dive right in.
Stan Duptal writes: At 70, my wife and I getting a divorce. She will list her principal residence as the cottage. I will list our home as mine. Both will be passed on tax free.
Peter Lillico replies: Hello Stan. From 2009 forward, you and your wife can treat the house as your principal residence and the cottage as her principal residence. This will exempt all future gains on both properties from taxation. However, for the period of time from the date of acquisition of the cottage and house to 2009, only one principal residence exemption is available. The pre-existing capital gains liability does not retroactively vanish upon a property becoming a principal residence. Your wife and you and your lawyers will have to take this into account.
Shaun McDonnell asks: As our cottage has appreciated more than our house and by default, the capital gains would be greater on the disposition of the cottage. Should I consider claiming our cottage as our principal residence? If so, when would I elect to claim it as our principal residence, on the deemed disposition of our house?
Peter Lillico replies: Shaun, you should certainly consider allocating your principal residence exemption to the cottage. You only have one principal residence "card" and so you want to use it to exempt the maximum possible tax liability. You must make your decision to use the exemption on the disposition (sale or gift) of either the cottage or the house. The good news is that you have until April 30th of the year following the disposition of one property to make your decision, so there should be lots of time to determine how best to use the principal residence exemption.
Also, the fact that your cottage has increased in value more than the house does not "by default" mean that it has a greater taxable capital gain. Don't forget the value of capital improvements that affect this calculation. If for example you built a $75,000 boathouse, replaced the roof for $5,000 and put in a new septic system for $10,000 - all of those capital improvements increase the cottage's cost base and so reduce the capital gains tax liability.
Michael Laroche asks: After the parents pass it to the children, in this case as a joint tenancy, what is the best course of action for those aging owners for their children?
Peter Lillico replies: After the parents have transferred ownership to the children, the best possible next step for the parents is to motivate the children to obtain a cottage agreement. This legal document will prevent the transfer of the cottage to non-family members: set out how expenses are to be shared, determine periods of exclusive usage, provide how decisions are to be made by the multiple owner children (and how to resolve the inevitable differences of opinion before they become disputes). A cottage agreement is the last, best chance the parents have to be certain that the cottage succession to the next generation is successful, in the sense of it staying in the family for more than a few months or years.
Mary from Toronto asks: It's my grandparents who have the cottage and will soon need to pass it down. Problem is that none of their children are interested in it. Too remote, too dim, too small. They plan to sell and divide. A few of their grandchildren, however, are very interested in the place. The problem is we're five to ten years away from being able to buy out our parents. Is there a line of argument to get them to hang tight you'd most recommend?
Peter Lillico replies: This is one for the grandparents to decide. It's their cottage, and its future as a family cottage rests in their hands. If they want it to be retained as a family cottage for the benefit of grandchildren and future generations, then this could be proposed to them. If they agree that because of the lack of interest by the children, it's preferable for the grandchildren to have the opportunity and responsibility, then they can sell it to them at the appropriate time or provide for this in their will, leaving the balance of the estate to their children.
If they themselves don't care if the cottage is kept in the family, or for other reasons don't want to skip over children to grandchildren with an inheritance, then it won't happen. But if the grandchildren are to inherit or buy, it is an essential first step for a cottage agreement to be worked out with the grandchildren. If they can't agree on how the cottage is to be used and paid for at this preliminary stage, then there's no realistic expectation they will be able to co-operate effectively as joint owners later.
Gregg Broks asks: What is the best ownership structure for families to use when purchasing and building a cottage? I have three siblings and we have all been saving money to purchase a lake lot in Kelowna, BC. We would further build a house to accommodate the four families.
Peter Lillico replies: Good question, with no single correct answer. There are various ownership structures available, the three most common are: direct ownership among siblings, with a cottage agreement; trust ownership, with siblings as trustees and siblings and their children as beneficiaries; or limited liability corporation ownership, with family members as directors and shareholders.
Each of these has different characteristics, tax implications and cost consequences. Your family is very clever to be looking forward and preparing for the purchase so that all will be agreed upon and organized effectively when the happy day arrives and the lot is purchased. Use that time wisely by doing the research on the various ownership structures and, with the help of professional advisers like a lawyer and accountant, decide which one suits your family circumstances and goals best.
Ken wants to know: What if the family cottage is handed over to the children, who are not all financially well off to pay the bills? Do you opt to buy the other sibling out or make rules for which people pay?
Peter Lillico replies: Good question, one that all families considering multiple ownership of the cottage need to address. It's not just a possibility but an inevitability that expenses will arise. Minor ones like paying a share of the municipal taxes may cause no problem, but when the septic system needs to be replaced some siblings may have their share, while others can't contribute. This is another reason why a cottage agreement is essential.
It will provide the solution, which could include: dipping into the budgeted cottage reserve, providing that a loan could be taken out against the cottage, to be repaid over several years equally and affordably by all siblings, or that the sibling who can't afford to pay his or her fair share can have his or her interest in the cottage bought out by the others. The agreement will set out in advance how the purchase price is to be determined and paid, for fairness to all.
Having a cottage agreement will be the answer to most of the problems that arise over the years. If it is properly prepared with the assistance of an experienced lawyer, then it ensures that inevitable difficulties don't blossom into disputes that lead to family friction - or the sale of the cottage.
Gary Bowman asks: Are there any strategies to avoid the capital gains tax completely, when handing down a cottage?
Peter Lillico replies: Yes, they range from the most effective use of the principal residence exemption to an early transfer to the next generation, before the capital gains tax liability becomes significant.
Alexander from Waterloo asks: We own a cottage bought for about $25,000 and now assessed at $125,000. We are in early 70's with two children who wish to share the cottage and get along with each other. Can we add them now as joint owners?
Peter Lillico replies: You can, but remember that this will be a "disposition" of that portion of the cottage transferred to the children. Even though it may be a gift to the children, for tax purposes it's deemed to be at fair market value, and so Alex you and your wife will be reporting a capital gain next April 30th. Consult your accountant to find out how much, large or small. Then you can decide whether to proceed with the joint ownership idea. In many situations like this, the kids will contribute the tax cost so as to spare the parents the "hit," since it's to the children's benefit to receive the gift.
John Hinkley asks: Is having sufficient life insurance, with the kids as named beneficiaries, the best way to handle the tax hit?
Peter Lillico replies: No John, it's not the best way. The tax hit will fall upon the estate, not on the kids personally. The preferred designation on the insurance is "estate." Then the proceeds will come to the estate and be available for the intended purpose when the tax bill arrives. If you leave it to the kids, one might prefer to spend his/her share on a trip rather than reserve it for the tax liability. Or, if a child is going through a separation or divorce at the relevant time, or has creditors, the insurance proceeds may be claimed by creditors or divorcing in-law, and again not available for the intended estate taxation need.
Adrian asks: My sibling and I will be inheriting a cottage and the looming problem will be upkeep - not financial, but the inevitable chores and maintenance. We have work agreements in place, but my sibling consistently fails to meet his obligations (cleaning eaves, taking down trees, replacing sign posts etc.). An income trust has been set aside for upkeep, but I feel that this fund should be for property tax and major repairs rather than hiring professionals for every small job. How do you go about an agreement that works and has consequences for failing to meet obligations, so that one person does not do it all?
Peter Lillico replies: Too bad the cottage agreement wasn't already in place, but try to negotiate one now. If there's resistance, you have the right under the Partition Act to force a court ordered sale. If that doesn't motivate co-operation, then go through with the sale and buy your own cottage with your share of the proceeds.
Anne Hemsworth asks: Our mother died 20 years ago, leaving the family cottage to my brother, sister and I. At the time of her death, she also rented an apartment in the city, so I am assuming that the cottage, where she had previously lived full time with my father until his death, can be deemed her principal residence. Is this correct? What do we need to do at this time, to move the ownership of the cottage into our names and out of the estate?
Peter Lillico replies: You need to retain a lawyer. He or she will organize the necessary documents, typically a Transmission Application and Transfer. It may also be necessary to "probate" the will, if this wasn't done 20 years ago. And don't forget the cottage agreement at the same time, you'll be glad you did.
Roma Luciw, Globe Investor: That is all the time we have. Apologies to the many readers whose questions we did not get a chance to answer. Thanks again to Peter Lillico for taking time out of his busy day. Hopefully today's discussion will result in a lot more happy cottagers, with a few more pennies in their pockets.