Besides fighting through traffic snarls to get there, the family cottage by the lake has typically been viewed as a place of tranquility with a lifetime of fond memories.
For older vacation-property owners looking to hand ownership down to the next generation, however, the process can cause plenty of financial headaches and family drama without the proper planning.
On the financial side, capital gains costs could be steep when passing on generations-old cottages – even before the recent run-up in property values. Add family dynamics to the mix, and what should be a simple exercise gets complicated quickly.
“The old-school thought is everyone loves the cottage and they’re all nice kids and all I need to do is die and everything will be fine,” says Peter Lillico, a lawyer with Lillico Bazuk Galloway Halka of Peterborough, Ont. “The reality is those are probably the cottages, the year after the parents have died … that have ‘For Sale’ signs.”
Mr. Lillico, who has 40 years of experience in cottage succession planning, says there are many techniques to address “obvious” financial issues, while navigating family politics can prove more challenging.
He says many parents assume that the kids get along; “therefore, when a cottage issue arises, or one of the kids gets divorced, or one of the kids goes bankrupt, it will work out.”
Too often, that’s not the case.
One way to ensure that the generation transition goes smoothly is to lay out in writing issues such as access to the property, responsibilities, overhead costs and sales options such as granting a right of first refusal to other family members.
For Ngoc Day, a fee-only certified financial planner with Macdonald Shymko & Co. of Vancouver, the two main issues for the next generation stem from ongoing financial costs for items such as upkeep, utilities and taxes and equitable access to the property.
“I will position it as a fractional share” when multiple siblings are taking over ownership of the property, she says. “You respect the other owners, and they have benefits, rights and obligations and they respect yours.”
Typically, she holds a meeting with the offspring to gauge their interest in owning the family cottage. In some cases, some children don’t want a stake, either because they don’t have kids, have moved away or can’t afford it.
In those cases, the other children “will buy it off the estate and have that subtracted off their inheritance,” she says.
The financial and family issues of cottage succession come amidst the largest wealth transfer in history, namely baby boomers to their mostly millennial-aged kids. That poses problems of its own.
“As assets are being evaluated for transfer to the next generation, the cabins, the cottages, they are part of that [wealth transfer] puzzle,” says Nicco Bautista, a lawyer and director of estate planning with BMO Nesbitt Burns in Vancouver.
In most cases, transferring a cottage (or cabin in B.C. parlance) will incur a land transfer tax as well as a federal capital gains tax to account for the rise in the value of the property. That may be reduced in part if it served as a primary residence for any significant time period.
“That’s coming out of mom and dad’s pocket unless there’s some arrangement that the kids make them whole. But most likely that’s from mom and dad,” Mr. Bautista says.
Simply gifting the kids the cottage doesn’t avoid capital gains since the Canada Revenue Agency considers it a sale at the property’s fair market value.
Ongoing financial responsibilities, such as paying any mortgage on the property or annual carrying costs, are typically the responsibility of the new generation of owners.
If someone in the next generation owns a business, or there’s a worry about the potential of divorce, one solution is what Mr. Lillico refers to as a “sprinkling cottage trust” or asset-protection trust.
In essence, it will protect the owners for 21 years from third-party claims from divorce, creditors or trustees of bankruptcy.
“That’s big,” Mr. Lillico adds.
The 21-year trust also provides “generation-skipping” of capital gains tax, allowing the second generation to pass the property onto their kids without incurring capital gains for the period it was owned in a trust.
For the older generation thinking about cottage succession, the most significant financial risk is putting it off, Mr. Lillico says. He gives the example of paying the capital gains and handing over the keys at 65 or waiting until 85.
“Do you bite the bullet and deal with the capital gains tax now for this generation and pay a lesser amount but sooner, or go the deferral route and it has quadrupled?”
He acknowledges that family and finances can make for a complicated cottage stew for the oldest generation.
“It boggles them because there are so many moving pieces and then they end up just walking down to the end of the dock and popping a beer and thinking about it for another year.”