Family legacy: How to pass along the family cottage—and 3 things to avoid

There’s no one-size-fits-all solution. “Planning has a lot of moving pieces, and it’s very important to get it right, and it’s very easy to get wrong,” says Peter Lillico, partner at Lillico Bazuk Galloway Halka Law firm in Peterborough, Ont. He is also a speaker at the Cottage Life shows. “Every family is unique, every cottage is unique, and every cottage succession is unique.” Here, he breaks down the common misconceptions Canadians have about estate planning around the family cottage.

Myths around cottage succession 

Identifying any potential issues is the first step in navigating how to transition the family cottage effectively. Let’s look at some common misconceptions and the solutions that work.

1. Assuming everybody will get along

Many parents assume that their children and other family members will agree on how to use and maintain the cottage. This is a mistake because it overlooks the potential for conflicts and differing expectations.

For example, take a family with two adult children, one living in Alberta and the other in Ontario. The one who lives close to the cottage in Ontario may use the property quite often. However, if the expenses are split 50/50 between both, this can lead to arguments. Lillico says: “There are cottage sharing agreements that can, and should, be worked out beforehand.” Parents (and/or their adult children, frankly) can create agreements that outline rules around care and expenses, and whether they should be shared equally or allocated in proportion to usage, or whatever the family wants. 

A cottage sharing agreement is a binding document that passes the ownership and control from one generation to the next. It doesn’t just include estate planning details, but also future rules around the cottage. It contains structured instructions for financial responsibilities, sharing usage concerns, division of ongoing labour and maintenance, and even dispute resolution. Lillico explains a real estate lawyer can help with the cottage sharing agreement, as well as “a worksheet that helps [parents] to consider how well suited the kids are for cottage ownership.” 

2. Underestimating capital gains tax

Some Canadian cottage owners may believe that succession of the property will leave their children with a valuable asset, but many underestimate the costs of capital gains tax and unforeseen maintenance expenses.

As real estate prices increased over the years, the family cottage may have risen in value significantly, especially if it was purchased decades ago. This leaves owners facing capital gains tax when they sell the property. Capital gains tax is levied on the profit of the cottage, which is considered a capital asset. 

Capital gains and losses are calculated based on the difference between the selling price and the original purchase price, adjusted for certain eligible expenses like renovations and improvements. (So, keep those receipts to lower the gain!) 

A loss can be used to reduce owed taxes on a personal income tax return. A gain, however, is taxed, but not all of it. The taxable portion of a gain is divided in half, and that amount is added to the individual’s overall income and taxed according to their income tax bracket.

“A succession plan might benefit from an early transition while the parents are still alive, before the cottage goes up another 10% or 20% or 30%,” says Lillico. “Then that new increase goes into the children as capital gains.” This would protect the parents from the asset’s expected growth in the future; the parents pay capital gains tax on the property by subtracting the transition price of the cottage from the purchase price they originally paid. The children would then own the cottage with the transition, and in the future when they sell the property, the capital gains would be calculated on any increase in value from the date of changeover to date of sale and reported on the children’s tax returns as income. 

Sometimes a family member lives at the cottage. So, another consideration is that a principal residence exemption can apply if the cottage was designated as the primary residence, which can help reduce or even eliminate the capital gains tax. It’s essential to consult a tax professional or an accountant for personalized advice.

3. Not considering other family dynamics

Transferring ownership of a cottage in Canada to a child can carry inherent risks—for example, what if your child’s marriage breaks down or they become bankrupt? In the unfortunate event of a divorce, if the child’s spouse has a claim to the cottage, it can jeopardize the family’s intentions to keep the property within the bloodline.

Additionally, if the child faces financial difficulties leading to bankruptcy, the cottage could be at risk of being included in the bankruptcy proceedings, meaning a forced sale to settle any debts.

Lillico advises that a sprinkling cottage trust could be the solution here. “With a sprinkling cottage trust, the cottage would be exempt from claims on separation or divorce or claims by creditors for up to 21 years after the parents have passed.” This trust can be a valuable tool for families looking to maintain a cottage as a shared asset while managing the associated financial responsibilities and tax implications effectively.

Who to hire to ensure a solid cottage succession plan

Leaving a cottage to children isn’t as straightforward a process as many Canadians might think. In reality, it can be legally, and emotionally, complex. Estate planning professionals can guide families in creating comprehensive plans that consider all scenarios, addressing potential conflicts and preserving cherished traditions. Their expertise can help ensure that the cottage remains a source of joy and togetherness, rather than becoming a point of contention or financial burden. Involving these professionals, such as a planner, lawyer or tax professional, is an investment in the long-term success and harmony of cottage succession.

Read more about owning a cottage:

• A guide to cottage insurance
• 4 ways to pass along the family cottage
• Reducing capital gains on a cottage
• Is a vacation home a good investment?
• The best 5-year fixed mortgage rates in Canada

About Debbie Stanley, TEP, MTI

Debbie Stanley is an estate and trust professional, and CEO of the estate firm ETP Canada. She is a writer, speaker and regularly featured guest on Zoomer Radio.

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