How avoid conflict when handing down the family cottage

For many families, weekends and vacations spent at the cottage are among their most enjoyable and memorable experiences together.

As we head into prime cottage time, many people will be looking forward to heading to the lake to relax and create new memories with family, friends and neighbours.

But all the emotion tied up with the family cottage can also make for some difficult decisions when it comes time to transfer ownership from one generation to the next.

The issue of what’s going to happen to the cottage is probably on lots of minds these days because vacation properties have sky-rocketed in value, along with other real estate during the pandemic.

So, what is the best way pass on a cottage? First, let me say from the outset that the golden rule when dealing with the family cottage is to discuss issues openly with everyone involved as early as possible.

These are often not easy conversations and that’s why many families put them off. The years can roll by with informal arrangements taking hold and issues only coming to a head when the parents either decide they don’t want responsibility for the cottage anymore, become incapacitated or die. That’s when disagreements, misunderstandings and resentments can lead to unfortunate family rifts.

A much better route is to have family meetings where everything is put on the table, including which adult children are interested and able to own the property and how upkeep, utilities, taxes and use of the property will be shared among siblings.

When it comes to the actual transfer of ownership from parents to children, here are three options for passing on the cottage.

1. One or more of the children take ownership—The parents can give the cottage to one or more of the siblings. However, you have to be careful about how you do this to avoid paying double capital gains tax. An outright gift of the cottage will trigger an immediate capital gains tax bill on its fair market value to the parents. And, because it’s a gift, CRA will deem the cost base for the new owners (the children) to be zero dollars, meaning the new owners don’t get credit for the tax paid on its value up to that point.

A better way to do it is to get an experienced lawyer (or notary in Quebec) to draw up a promissory note in exchange for “selling” the cottage at the fair market price to the children. While the note is deemed payable by the new owners on demand, it is forgiven in the parents’ will. Under this arrangement, the adjusted cost base to the new owners for capital gains tax is set at the fair market value at the time of the transfer.

This leaves the question of how siblings who are not taking ownership of the cottage are to be compensated for their share of its value. Typically, this is equalized by the non-owning siblings getting a greater share of the parents’ estate, to compensate for the value of the cottage they didn’t get. This can also include an extra sum to recognize that the other sibling got a portion of their inheritance early. This can compensate for the appreciation of the cottage between the time of the ownership transfer and the settlement of the estate. The caveat is that you have to have enough other assets in your estate to compensate the non-owning children for the value the other children got in the cottage.

2. Will the cottage to the children—Parents often simply leave the cottage to their children in their will. Ideally, there are enough assets in the estate to cover the capital gains tax and the parents already know who among the children is interested in owning the property. The children who aren’t interested can be compensated for its value by getting a greater share of the other assets in the estate.

Alternatively, the siblings who are interested in keeping the cottage can buy out the others, assuming they can afford to do so. In their will, parents often include a time limit (one year, for example) for the children to decide who is interested in the cottage, have it valued and settle ownership, or else it will be sold, and the proceeds divided equally.

To avoid conflicts among siblings, many parents ask their children to sign a co-ownership agreement that outlines rights and responsibilities, including how time at the property is to be  shared, and how maintenance, property taxes and other bills are to be handled.

3. Set up a trust—It’s also possible for parents to put the cottage into a trust and transfer it to the children as beneficiaries. The parents can also put money into the trust to pay for maintenance, taxes and other bills. This can mean that children who wouldn’t otherwise be able to afford the cottage can continue to use it.

Placing the cottage in a trust would trigger capital gains tax (unless the principal residence exemption can be used). However, once the transfer is made capital gains accrue to the trust and tax has to be paid only after 21 years when, by law, there is a deemed disposition of the trust property at fair market value. A trust can also protect the property from being claimed in a marriage breakdown or by creditors in a bankruptcy.

It’s important to note, that a trust is more costly to set up and maintain, so you should have clear goals for taking this route.

In estate planning, the worst outcome is to surprise your children with the decisions you have made. That’s why it’s so important to have clear, comprehensive, and open discussions about these matters with the whole family.

Planning and executing the transfer of a cottage in a way that’s fair to everyone will reduce the risk of conflict in your family. However, it’s complex work—more complex than can be covered in a short article.

That’s why it’s essential to get advice from experienced professionals. They can explain the pros and cons of different options to you and your family and help you find the best solutions for your situation.