Passing the cottage on to the next generation

The "lazy, hazy" days of summer are here and many of us will be leaving the city life to enjoy a family cottage. For many, these properties represent the second largest financial investment of our lives. There is, however, an important difference between this property and your primary residence. On the last death of you and your spouse there will likely be a significant tax liability. We can help.

Tax Considerations

There are many thing to consider in any succession plan; however the most serious financial obstacle to passing the cottage on can be the capital gains tax liability (50% of the gain). The evolution of the changes to the tax rules on this subject has forced us to develop ways to pass the cottage on in a tax-efficient manner. Fortunately, there are strategies we can use to help deal with any impending tax liabilities.

Who Should The Property Go to?

For some this is a greater concern than future tax liability. the question of who to leave the property to is paramount. The best solution may not be to leave it equally amoungst one's children. The children man not have the same interest in its future use, and a cash bequest from other assets may be more appropriate to those who do not want the property. You may want to take some time this summer to have an open discussion with your family to determine who has an interest in using the property and paying the costs of future maintenance.

If the parents are over 65 an 'alter ego' or 'joint partner' trust could be used, with no deemed disposition of property when the cottage is transferred into the trust.

You may even have considered transferring the cottage into joint names withe eventual beneficiaries. While this may have the effect of passing it on by "rights of survival" at death, it has major drawbacks. There would be a capital gain at the time of transfer; the property would be in "joint control" with all the owners; and it would be subject to claim if there were a marriage breakdown or by creditors of any of the owners. Clearly, not a good solution.

Insurance Policies

Life insurance can be a very cost-effective method of providing liquid cash to pay any capital gains. Insurance can be purchased on the single owner or, as is most often the case, on the joint owners (Mom and Dad). The policy would be a "joint last to die" and because tow people are insured, the cost will be less than either could buy individually. The proceeds of the insurance are tax free to the beneficiaries. In some cases the beneficiaries of the cottage (and of the insurance) pay the premiums. The only potential downfall to this solution is that the owner(s) of the cottage must be in good enough health to qualify for the insurance. Because this may not always be the case, let's look at another option.

Transfer To Trust

Consideration should be given to transferring the cottage to an 'inter-vivos' (living) trust if there is currently a small capital gain. The transfer of the cottage into a trust triggers the capital gains effectively transferring any further future capital gains to the beneficiaries.

A "discretionary" trust can be useful when it may not be clear a to which children have an interest in the property. The transfer can take place into this trust and owners will have unlimited use of the property as well as complete control. This would allow time to decide who the beneficiaries will be. At some later date the property can be rolled out of the trust to the beneficiaries, at the value it was rolled into the trust originally. This will have the effect of deferring the tax until the property is sold.

Conclusion
The family cottage can be a source of great enjoyment and fond family memories. It's important to plan for the appropriate transfer and to provide to liquid cash to pay any taxes. By taking a small amount of time today to plan for this event, a great deal of expense and frustration can be avoided in the future. We strongly recommend that you see a qualified legal & tax advisor about the options available to you before deciding on any course of actions with respect to cottage succession planning.

Taken from: "The Canaccord Connection - Summer 2007"