Who gets the family cottage … and how?

Holding onto memories while letting go of ownership

Some of the hardest estate planning decisions are not about dollar values, but about personal values. A prime example is the family cottage, where the memories are many, and the mere mention of letting-go can be painful.

Unfortunately, it’s not much easier on parents who intend to keep it in family hands rather than sell to strangers. Among those you love, it can be even more emotionally troubling to decide when, how and to whom ownership will pass.

To prepare for these tough choices, it’s helpful to have a clear understanding of tax and legal rules so that you can anticipate hurdles and consider options.

Tax liability for parent as seller/transferor

Apart from spousal transfers, a change in beneficial ownership is a taxable disposition. Half the increase in value from the adjusted cost base (ACB) to the fair market value (FMV) is added to the seller/ transferor’s income for that year. The ACB is generally the acquisition price plus capital improvements.

The tax bill could be reduced by claiming the principal residence exemption (PRE), though that would limit use of the PRE on a future disposition of other concurrently owned residential properties.

Options for passing ownership to one or more adult children

In an arm’s-length sale, a seller transfers ownership without control or concern as to how that arm’s length purchaser holds title. In family situations, there are more options that parents may consider:

Direct transfer to one child

Even if little or nothing is paid in return, a full disposition is deemed to occur at FMV for purposes of calculating the capital gain. Thereafter, the child has all rights of ownership.

Adding joint owners

A proportionate disposition is deemed for each added owner. For example, a widowed mother who adds 2 sons is deemed to dispose of 2/3 of the value. The later death of any joint owner is a disposition of that person’s share, with the survivors continuing to own the property together.

Using tenancy-in-common

A parent could direct a specified percentage to transfer to one or more children, to be held as a tenant-in-common. Like joint tenancy, there is a disposition on initial transfer and on an owner’s death, but the deceased’s rights pass to his/her estate, not to the surviving owners.

Tax-deferred trust transfer

Parents over age 65 could transfer the cottage into an alter ego or joint partner trust for their current benefit, with the children as contingent beneficiaries. The property is not deemed disposed until both spouses die, at which time capital gains would be calculated and tax due.

Transfer to a lifetime trust

The parents may be content to trigger a taxable disposition to a trust now. They could maintain legal control as trustees, with future gains accruing to the children as beneficiaries.

Estate distribution possibilities

If the cottage is held to the second spouse’s death, the capital gain arises at that time. The cottage could then be transferred to the children (tenants-in-common or joint owners, as desired) or continue to be held in trust according terms as outlined in the last deceased’s Will.

Funding the tax liability

Allowing that the PRE may be claimed in some situations, tax on the capital gain is usually inevitable. And if it’s large, the decision may be to delay triggering it until death. Parents could buy joint last-to-die life insurance to pay the tax, or allow that other estate assets will have to be sold to raise the needed cash.

Hidden costs of cottage ownership

All decked-out at your cottage, cabin or chalet

You look out across the rippling water admiring the rise of evergreens painted against an indigo sunset. A warm breeze on your face, a deep relaxing breath, a cold beverage at hand … priceless, right? Wrong.

Whether you’re reminiscing from younger days, recalling a recent visit with a friend or just holding an image in your mind, cottage life can be very appealing. Savour these memories fondly, and dream what feelings the future holds.

At the same time, you need to be thinking both conceptually and practically about the cost of that life of leisure. Without puncturing those visions entirely, let’s look at some of the costs and trade-offs of owning vacation property.

There and back again: The cottage commute

Be sure you are up to the travel back and forth. Weekend cottage migration can be time-consuming and costly, as gas is obviously not free.

If you are able to work remotely, maybe you can ease your woes by heading up a weekday earlier or staying on while others join the Sunday stream of headlights. That can be a sanity-saver but can also impose its own costs, especially if you need rural high speed internet access.

And if you’re breaking the family into two vehicles to coordinate commuting, that convenience will cost you.

Year-round or seasonal? Measuring your maintenance

Is this your getaway or a duplicate home? Either way, you need furniture (rustic though you could choose it to be), appliances and the periodic roof, fence or deck mending.

For bills and utilities, some will vary by usage or may be available seasonally, while others like property tax will apply annually. For year-round access, you may need a local snowplow contractor, or at least own a dependable snow blower.

Careful not to be trapped by the trappings

Just being at a cottage is good for some, but ‘doing’ is what many people look forward to.

Often that means being out on the water, or at least at its edge. That can range from a foam floaty, to a canoe or kayak, all the way up to a powerboat with water-ski line.

Again, there’s the cost of gas? Though smaller items can easily be packed away, motor craft will have to be winterized and may require offsite storage.

Keeping it clean and tidy, and sharing your good fortune

Do you like housework?

Hopefully so, because you now have two houses to take care of. Don’t mean to rain on the parade, but we all had chores at our family cottage, and they doubled-up when we had guests coming.

Of course, welcoming visitors is a large part of the charm (and it’s a good antidote to cabin fever with one’s family), but guard yourself against going from gracious host to inundated innkeeper.

Renting to ease the finances

If you’re stretched to carry the place, whether from the outset or once you’re established, you could consider renting it out to defray some cost.

This is a lifestyle concession as much as a financial boost, as you may have to concede prime times when you would like to be there yourself. But with prices being at historic highs, this may be the route for you if you are intent on making cottage realty your reality

US and other foreign recreational properties

Estate planning informing vacation planning

For decades, Canadian parents have piled their kids and pets into the car for the weekend trek to the nearby cottage, cabin or chalet.

These days, it is not uncommon to have a vacation property in another province or outside the country altogether. That’s an extra layer of complexity to contend with when thinking about selling or transferring the family getaway, including preparing for estate and capacity planning.

Wills and estate transfers

Generally, a Canadian Will is effective to deal with a person’s real property (real estate) in the home province, and personal property wherever it may be. In order to deal with real estate elsewhere, the Will has to be proven to the satisfaction of the courts/law in that other jurisdiction. While this is not an impossible task, it carries with it additional cost, time and potential uncertainty.

A second Will where the property is located?

With that in mind, it may be desirable to plan ahead by executing a second Will in that other jurisdiction. In so doing, it is crucial that the second Will doesn’t inadvertently revoke the person’s main Will, or otherwise alter distribution. An open dialogue between the lawyers in the two jurisdictions should keep plans aligned.

Discussions with the foreign lawyer should include gaining an understanding of tax obligations (currently and for the estate), and legal responsibilities of the executor. This may necessitate adjustments in the home Will, or at least some informal guidance.

Alternatively, it could lead to naming a distinct second executor, with appropriate allocation of powers and constraints between the two. This knowledge may even affect the owner’s longer term intentions for the property.

Incapacity while owning or being abroad

Arguably, the estate transfer is the easy situation as compared to responding to a crisis while an owner is living. For one thing, death is obvious, but incapacity not so much so. And while an estate transfer is a property matter, there are both property and personal issues to address while a person is living, with attendant greater urgency.

The act of naming substitute decision-makers has been a recommended part of estate planning for decades. The traditional term “power of attorney” (POA) is still used in many jurisdictions, and is otherwise understood as a generic reference even if other formal phrasing applies. And while it is usually intended that the power be exercised wherever the grantor or property may be, challenges can arise when foreign elements are involved.

Each jurisdiction has its rules on the execution process, witnessing, allowable language and format – sometimes requiring official forms – any part of which may be at odds with the home jurisdiction’s rules. Even if there are no such formal impediments, there can be delays (and associated costs) as individuals, health care workers and businesses assure themselves of their obligations, perhaps even requiring them to seek their own legal advice before being able to take instructions.

One may ask why there isn’t a common form and rules to get around these complications? Indeed, efforts have been made to do just that over the last decade through recommendations from the Uniform Law Conference of Canada and the Uniform Law Commission in the United States. However, it’s up to each province and state to decide whether to adopt these recommendations, and to date only a handful have gone that far.

Parallel POA planning

As with Wills, it may be desirable to have POA documents drawn up in the foreign jurisdiction in order to expedite action at critical times. In addition to the provisos about guarding against revocation and having open communications, some further questions should be canvassed:

- Can the same person be named in both jurisdictions? Are there practical/logistical/linguistic concerns that may lean toward naming a different person in the foreign jurisdiction?
- What events may cause an appointment to be revoked (eg., marriage, separation, bankruptcy)? If such rules differ between the jurisdictions, how will that be reconciled?
- What is the scope of the attorney’s activity for each jurisdiction? Are there gaps, how will they be handled?
- If it is intended that the home jurisdiction attorney has ‘final say’, is this possible under the foreign jurisdiction’s rules? How can an attorney be removed?
- Is compensation allowed/required/prohibited, and do the planning documents together guard against double-compensation?
- What checks are there to assure appropriate accounting and accountability for each attorney’s actions?

Tax points to ponder – Property in the United States

Given our geographic proximity, most of this cross-border planning will be with our neighbour to the south – or to the north if you’re crossing to Alaska. In fact, it is critical to appreciate that just like our provinces, each American state has its own rules. Accordingly, each individual/couple/family will need to cater their planning to their home province and the state that welcomes them.

And despite that we are near neighbours, we also can’t forget that the United States is a foreign country with its own tax rules. Like Canada, there are income tax powers at both the sub-national (state) and federal levels. Here are some important tax matters affecting Canadian owners and sellers of US recreational property.

Tax reporting on sale, including principal residence

Sale of a US property must be reported on a seller’s Canadian tax return, on a US federal return, and on a US state’s return if there is a state income tax. Capital gains are taxable in both countries, with the US gain based on the change in property value, and the additional factor of the exchange rate affecting the Canadian calculation. In theory, there could be a capital gain on one side of the border and a capital loss on the other. Ordinarily though there will be a gain for both, and Canada generally allows a foreign tax credit for US tax on a sale.

The Canadian principal residence exemption (PRE) can apply to property outside of Canada. The property may still be exposed to capital gains tax on the US side, as a foreign tax credit could not be claimed in Canada, since the PRE claim would result in no associated Canadian tax against which to use that credit.

Withholding tax on sale

When a foreign owner sells US real estate, the purchaser is required to withhold up to 15% of the selling price and remit that to the US Internal Revenue Service (IRS). The percentage can be reduced depending on the selling price and whether the purchaser intends to occupy the property. The withholding rate may be further reduced or eliminated if the seller obtains a certificate confirming that the ultimate US tax liability will be lower than the withholding rate. Otherwise, the seller can recover the tax by filing a US tax return following the sale.

US estate return and US estate tax

At a Canadian owner’s death, the executor for that non-resident must file a US estate tax return if the fair market value at death of the decedent’s US situated assets exceeds $60,000, regardless whether any tax is due.

As to that tax liability, real estate owned by a Canadian is US-situs property for the purposes of the US estate tax, but only if their worldwide assets exceed the exemption threshold, which is US$13,610,000 in 2024.