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What to do with the family cottage

Planning around a cabin is not like other financial planning.


Date: August 29, 2016

Most clients think of their cottage as their refuge away from the busy city, not an asset that has likely grown in value over the years. Cottages, though, are indeed an important asset and a valuable one at that – many have seen their prices grow exponentially since they were bought, often decades ago.

Because of this, and the fact that it’s usually a family cottage that multiple family members want to use, what one does with this piece of property must be carefully considered.

“When you compare it to a traditional investment like a mutual fund, there are a lot of emotions that go along with a cottage,” says Michelle Munro, Director, Tax Planning, at Fidelity Investments. “One dad I know promised his kids he’d never sell the cottage. Now he’s hitting retirement age and thinking, ‘I don’t know if that was a good promise to make.’”

Planning around a cottage is different than traditional financial planning – it’s important to accept that there are emotions at play. Any plan should be documented in the client’s will and estate, and the client should be encouraged to include all family members in the discussions.

“Don’t assume the wants and needs of others,” says Ms. Munro. “Clients with young families may initially use the cottage regularly, but as they grow older, those children might not have the time and inclination. Parents might be surprised about the answers of the adult children. And circumstances and situations change. Parents might need the money from a cottage to fund their own retirement.”

Consider the taxes

When it comes to estate-related taxes, the biggest issue to consider when transferring the cottage to the next generation is capital gains tax on the disposition. The capital gain is the amount that the proceeds exceed the tax cost. Advisors will want to help clients minimize the amount owed to the government.

“Even if you gift the cottage, it works as if Mom and Dad had received the fair market value,” says Munro. “It still triggers a capital gain with proceeds at fair market value. And the adult children have acquired it at the same amount.”

Advisors can help reduce capital gains by recommending that clients document tax cost, which not only includes the initial cost but also the amounts they have paid on improvements to the cottage over its lifetime, says Ms. Munro. Make sure to have a running list with supporting invoices of those pricy renovations.

“The first rule is to keep your paperwork,” says Jason Abbott, a senior CFP with Inc. “This isn’t buying a new mailbox for the cottage, but major improvements.”

That could include redoing the deck, building a boathouse or other significant upgrades, but not basic repairs and maintenance. Tell clients to keep a simple spreadsheet and their receipts.

The next step in calculating the amount of the gain is determining the fair market value of the property.

“There could be a lot of variance even in cottages on the same lake,” says Ms. Munro. “[Factor in] soft things like the view, the quality of the shoreline, west-facing versus south-facing. This also comes down to documentation. What have recent sales been? How about appraisals?”

Calculating probate

The second major tax issue is the potential for probate fees on assets. Fortunately, there is a formula that makes it easier to figure out what a client’s heirs might owe. In Ontario, for instance, people will have to pay $5 for every $1,000 on the first $50,000 of assets, and $15 for each $1,000 above that amount, says Ms. Munro.

One way to get around these fees is to gift the cottage to children prior to death. Gifting only works if parents don’t need the money or don’t want their children to use their own assets on the cottage transfer.

Another way to reduce probate and capital gains is to change the title on the property to joint tenancy, with one adult child holding the right of survivorship, says Ms. Munro.

“Now three people own the property legally on the title, and the parents have only disposed of one-third of it, triggering a capital gain on that one-third” she says. “Upon the parents’ deaths, the remaining two-thirds triggers a capital gain and ownership flows to the adult child. The estate would pay the smaller capital gains.”

Mr. Abbott says that while this kind of planning is useful, it can be complex and can even backfire if the entire family isn’t on board.

The important thing is for you to know your client, he says.

“You have to balance financial with non-financial considerations,” he adds. “Sometimes paying more tax is the price for harmony. If there are multiple kids and the property goes into joint ownership with one of the children and not the others, it can create confusion.”

The best way to plan for a cottage transfer? Start talking to all the stakeholders early.

“Parents might have had the idea that the cottage is going to stay in the family, but if families can’t get along and kids can’t see eye to eye on how to manage it, it’s going to be sold or there will be an ongoing conflict,” says Mr. Abbott. “Start this conversation with the client early on.”

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