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Estate Planning and the Family Cottage


Ah, Summer! For many of us, summer evokes fond memories of sunny days, swimming, boating, sitting around a camp fire, and having barbeques with close family members and friends. Some of these memories may have occurred at a cottage property.

A cottage – whether on a lake or in the country – is a common asset in Ontario. While it can be a well- loved and well-used, I would argue that no other asset has the potential to cause so much trouble later on. As the name perhaps suggests, a “family cottage” is an asset about which everyone in the family – whether they actually own the place or not – has an opinion.

We have all heard stories about families self-destructing over the cottage after Mom or Dad dies. Unfortunately, such stories are all too common if proper planning has not been done. If you own a cottage, here are some important things to consider:

1) Tax, tax, tax!

Unless you do not own another residence in Canada, chances are high that capital gains tax will be owing if you sell or transfer your interests in a cottage, or if you die before you get an opportunity to do so. Canadians, whether single or married, are generally entitled to one “principal residence exemption,” which means that they can shelter only one residence from capital gains tax. Depending on market conditions and the values of their properties, many people have been protecting their properties within the Greater Toronto Area (GTA), thereby exposing their cottage properties outside of the GTA.

If you purchased your cottage for $50,000 back in the 1980s and it’s now worth more than $500,000, how will you – or your Estate Trustees (Executors), if you’re deceased – come up with enough money to pay the income tax owing on this increase in value? Selling the cottage is often the solution unless there is enough money elsewhere. Tax can be a key reason why few cottage properties remain within one family for more than two or three generations.

If you’ve made improvements to your cottage over the years, this can increase your “adjusted cost base” and potentially reduce the capital gains tax bill in the future, but have you been keeping proper records of these expenditures? If you cannot prove what you paid for the roof to be fixed, the dock to be replaced, etc., then the Canada Revenue Agency may disallow your claim, thereby increasing your overall tax bill.

2) Co-ownership can be awkward

“I have three adult children and currently all three enjoy using the property. What do I do?” With respect, remember that your children may enjoy using the property because 1) you’re currently paying for everything (i.e. property taxes, upkeep, etc.), 2) you’re still alive and they enjoy using it with you, and 3) you’re potentially acting as “referee” and fairly dividing up who gets to stay there during those precious long weekends in the summer. There’s a big difference between loving a cottage as guest and loving a cottage an owner or co-owner.

If you want to leave your cottage to all of your adult children (minor children are another matter and one you should discuss with your lawyer), then strongly consider only doing so if they enter into a “co- ownership agreement.” A co-ownership agreement could deal with important topics like who pays the bills? Who gets to use it and for how long? What about pets and guests? What about repairs? What if someone wants to sell his or her interests or gets divorced? What if someone fails to fulfill his or her obligations? If your children cannot agree on the terms of a co-ownership agreement, things do not bode well for them getting along as co-owners, so consider specifying that if no co-ownership agreement is signed within, for example, six months after your death, then the property must be sold to a third party.

I will mention that cottages can be put into trusts – whether the cottage owner is alive (an “inter vivos trust”) or upon his or her death (a “testamentary trust”) – but generally there’s a “deemed disposition” of capital assets every 21 years within discretionary trusts, which means that the capital gains tax bill mentioned in #1 above needs to be paid every 21 years. If there are no other assets in the trust, often the cottage itself needs to be sold to pay this bill. Plus, as the list of potential beneficiaries increases (e.g. your children have children) more potential problems can arise. It’s also now quite difficult to use the “principal residence exemption” for cottage properties held in trust unless strict requirements are met. Tax advice should be sought before any sort of trust is used.

To be frank, sometimes directing that the cottage must be sold to a third party upon your death can be the best way to avoid creating tension for the next generation, especially if you know the cottage holds sentimental value that is far greater than its actual monetary value.

3) What if only one child wants it?

One solution in this scenario is to give that adult child (again, minors are another matter) an “option to purchase” your interests in the cottage in your Will. That adult child, who should be specifically mentioned by name, should pay “fair market value,” which can be ascertained using an appraisal or the mid-point between two appraisals done shortly after your death. You may wish to specify that this child may use other property he or she may be inheriting from you to facilitate this purchase. In this scenario, it will be kind of like the cottage was sold to a third party and there will be enough money to pay the capital gains tax bill, but your Estate Trustees can avoid using a realtor and the cottage itself can remain within your family. Like with co-ownership agreements (see #2 above), I often recommend including a time limit – so the named child can’t “sit” on his or her option indefinitely – and if that expires, the cottage would be sold to a third party.

If you have two or more children who may potentially want an “option to purchase,” then you can specify in your Will how bidding should be done (for example, doing “blind” bids and the highest bid wins). In any regard, options to purchase can be a transparent way to treat children fairly, have enough money to pay the capital gains tax bill, and potentially keep the cottage within the family.

Another solution could be to leave the cottage to one child but to “equalize” its value – i.e. your other child or children get(s) the cash equivalent, assuming you have sufficient other assets to do this. This avenue does mean that you’ll be treating your children differently because they’ll receive assets of a different nature, but if everyone ends up with the same overall value of inheritance, then this can sometimes work out quite well.

Lastly, please be careful while you’re alive about transferring your interests in your cottage for “undervalue.” If you are considering adding one or more of your children on to title (ownership), or are considering simply giving the asset to one or more of your children for free, please speak with your accountant and your lawyer first, to ensure you are not accidentally creating tax or other problems. In some situations, a sale for fair market value, secured by a loan that you can direct in your Will be forgiven upon your death, may be the best method, but your tax and legal advisors must review and confirm this first.

This article is intended as information only. It is not legal advice. To better understand what estate planning may be appropriate for your particular situation, please consult a lawyer.

The foregoing should not be considered to be legal advice and should not be relied upon as such. Please consult a lawyer to get advice and an opinion on your unique circumstances.