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COTTAGES:  TRANSFERRING TO THE NEXT GENERATION

A cottage, or recreational property, is an estate asset which requires careful handling for emotional and financial reasons.  Emotionally, there are often many childhood or family memories that have been enjoyed at the family retreat.  Often the property has become a family meeting place.  Financially, recreational property values have increased substantially in recent years and with this increase comes a substantial tax liability.  Where the recreational property is not your principal residence, the increase in value since the later of, the date of purchase or 1972, is treated as capital gain and is fully taxable upon its sale or its deemed sale in the event of death.

Some options the property owner can consider and certain benefits and concerns which accompany these options are as follows:

1. The simplest option is to dispose of the property to a child, children or third party prior to death at fair market value.  One advantage of this alternative is that the net proceeds are easily available to children in whatever proportions the property owner decides in their Will.  The children will be free to use the money as they choose.  This has benefits when not all the children or their families are equally interested or able to make use of the recreational property.  The disadvantages are the possible loss of the property to a non-family member, the immediate triggering of capital gain at the time of sale and loss of use of the property during your lifetime.
2. An alternative is for the owner to leave the property in their Will to a child or children upon their death. This allows the owner to retain control and use during their lifetime and defer the capital gains tax until their death. If the estate has sufficient other assets they may cover the tax liability. Alternatively, the tax burden could be borne by the beneficiaries of the property. Yet another alternative is for the owner to obtain life insurance to cover the tax liability.
3. A hybrid of options one and two above, is for the owner to transfer the property to children during their lifetime while retaining a life estate. This allows the owner use of the property until their death, and triggers the capital gain immediately. While triggering the capital gain sounds like poor planning, it may make sense where the owner has the ability to pay the tax liability. The advantage of this strategy is that any capital gain on the property after the transfer accrues to the child/children. The owner may also choose to lessen the burden on the children by providing financing by way of a vendor take-back mortgage. The mortgage then becomes an asset of the owner who can choose to forgive the mortgage on their death or transfer the mortgage to whatever beneficiary they so choose.
4. A final option is to transfer the property to a trust during the owner's lifetime or on death. Care should be taken in choosing the Trustees who will be given the power to operate the property. The cost of maintenance and capital costs may be covered by the owner's estate, the beneficiaries or from funds transferred into the trust. This option has benefits where the children have disparate financial abilities. It is recommended that prior to any disposition, the owner and family discuss certain ownership considerations such as: time sharing, scheduling for weekends, vacations; rental; guests; maintenance expenses; capital expenses; buy-out provisions; dispute resolution. The assistance of an experienced professional to outline the variety of alternatives available and finalize a co-ownership agreement may prove beneficial.

By Rob Warrender
February 15, 2005