Tag: Succession

Thanks for the memories – Transferring the family cottage

I met my wife on the May long weekend about a decade ago, on the beach of the cottage that had been my summer home since I was a child.  It was the last – and most lasting – memory of about three decades our family had been there.  Earlier that spring we had decided among us that it was time to move on, and a week later my parents closed the sale to another young family.

For many though, the preferred route is to pass a cottage, cabin or chalet on to the next generation.  With the view from this year’s May long weekend toward summer on the horizon, here are some tax and legal issues to contemplate as a family looks down that road.

From one generation …

A transfer to anyone other than a spouse will trigger capital gains, including a proportionate deemed disposition if a non-spouse is added as a joint owner.  Per the usual calculation, fair market value less adjusted cost base yields the capital gain, half of which is included in the transferor’s taxable income.  Be aware that as this is generally personal use property under tax law, one cannot claim a capital loss if the figure is negative. 

The starting point for ACB will be the initial outlay to acquire the property, plus any capital improvements.  This may also have been bumped by up to $100,000 if steps were taken prior to March, 1994 to preserve the then-eliminated general capital gains exemption.  As with all tax reporting, good recordkeeping is essential.

To counter this tax, quite often the property can qualify for the principal residence exemption.  But bear in mind that the later availability of the exemption will be reduced or eliminated for overlapping years of ownership of other properties held by either spouse, so proceed cautiously.

The spectre of a hefty capital gains tax bill may lead some to delay transfer until the last death of the two parents.  Assuming this is a conscious plan, a sinking fund or joint-last-to-die life insurance policy might be arranged to pay the tax.  On the other hand, if this is the result of procrastination, it could merely guarantee the inevitable sale of the property if the estate has insufficient cash for the purpose.  

While such a delay may defer capital gains related tax, in some provinces the involvement of the estate will attract significant probate tax.  An alternative that may bypass probate and still delay capital gains tax may be to add an adult child as a joint owner while the parents are living, but with the beneficial joint entitlement only passing upon the last parent’s death.  This planning possibility arises out of the Supreme Court’s Pecore decision in 2007, and should be discussed with a lawyer to determine its possible application in an actual family situation.

… to another 

On the receiving end, there are relatively few tax complications where the property is transferred to a single child.  However, where there are multiple children and especially multiple generations involved, things can become challenging.

Joint ownership among siblings (or any non-spouses for that matter), can be messy in two major respects.  First, right of survivorship means that on a sibling’s later death, his/her interest passes to the surviving joint owners, whereas the more likely intention might have been for that interest (or at least the value) to fall to the deceased’s descendants.  Second, the now-deceased sibling’s estate could have a capital gains tax liability, in a sense adding insult to injury since the joint property interest will have passed to the surviving siblings.

An alternative to joint ownership would be to have siblings hold their interests as tenants-in-common, with the result that a deceased’s interest falls into his/her estate.  The drawback here is that it puts probate tax back on the table, not to mention the potential exponential increase in owners as the next generation comes on.

A more flexible alternative may be to establish a trust, of which the family members are beneficiaries.  This could either be an inter vivos trust the parents establish presently, or one or more testamentary trusts created out of their Wills.  Either way, it would be advisable to have a maintenance fund within the trust to facilitate general upkeep as well as capital expenses.

Some further factors that will influence the decision include: if, when and to what extent land transfer tax may apply; whether anyone has creditor concerns; how matrimonial law may apply; and additional complications associated with foreign properties, particularly exposure to US estate tax on properties south of the 49th parallel.    

Of course, this is not exclusively a tax and legal decision, but rather one that can have high emotional stakes.  So if there is already a battle over who gets access when, it may be better to just erect the ‘for sale’ sign and keep the memories intact.

EstateWISE – Succession of a family cottage or cabin

One of the great concerns of aging parents who own a cottage or cabin that has been in the family for years or even generations is that it will have to be sold when they die?  Are there other alternatives?

Why is there this concern that a cottage will have to be sold?

  • A cottage is a capital asset, and unless it is a couple’s principal residence, its growth will result in capital gains tax when it is sold — unfortunately, a sale is deemed to occur when a person dies 
  • You can delay that capital gains tax by rolling over the cottage to a spouse — during lifetime or at death — but on the surviving spouse’s death, the capital gains tax must be paid
  • Given the positive trend in recreational property values across the country, there may not be enough liquid estate assets to pay the tax and therefore the cottage itself may need to be sold to pay the tax

If this tax is unavoidable then is there anything that can be done to alleviate the problem?

  • The main thing here is to be aware that there will be a tax hit coming
  • Some people simply set aside liquid investments to pay the tax at death
  • It may be possible for the beneficiaries to mortgage the cottage to pay the taxes, and the current owner may be able to facilitate that with perhaps a standing un-drawn line of credit on the cottage
  • Alternatively you might arrange life insurance — possibly with premiums paid by the adult children —  with the insurance proceeds paid at the second spouse’s death when the tax arises 

Aren’t there new trusts that were brought in to help with estate planning?

  • Probate planning trusts have been allowed under the Income Tax Act since the late 1990s
  • Those over 65 might transfer the cottage into a joint partner trust without there being a taxable disposition, and this arrangement will avoid the probate tax of as much as 1.5%
  • Unfortunately, this type of trust is deemed to dispose of its property at the death of the second spouse at which time the capital gains tax will have to be paid

Why not keep it simple then and transfer into joint ownership with an adult child?

  • For estate planning purposes, joint ownership provides the benefit of allowing the cottage to devolve outside of the estate, and thereby avoid probate tax
  • Unfortunately once again, adding anyone other than a spouse is a disposition for capital gains tax purposes — in effect you pay part of the capital gains tax now, and pay another part at each death
  • As well, if the child dies first then you are back at square one, and there are other concerns about exposure to creditors and matrimonial law considerations

Family business succession

The succession of a business is often the last thing on an owner’s mind, or at least the last thing that the owner wants to deal with.

Unfortunately, as with death and taxes, the transfer of a business is an inevitability that cannot be escaped – and it’s those same two former issues that make the transfer so critical to plan effectively.

Of even more immediate and personal impact, unless an owner intends to travel to the great beyond directly from the shop floor, a well considered succession plan is essential to enable the owner to ease into a stress-free and financially secure retirement.

Ultimately the goal is to provide certainty – either at retirement or death – about who will succeed to the business, and how and when that process will be carried out.  The key is to be prepared.

Preparing the successors

Selecting a successor involves a combination of commercial and emotional considerations.  

Particularly for a family business, the succession plan is intimately tied to the owner’s estate plan. The owner must not only decide on the appropriate successor(s) but also be prepared to deal with those who are not chosen, and the possibility that the business will have to be transferred to management or sold outright to strangers.  

Some issues to consider:

  • How should family and management be involved in the succession decision? 
  • How and when should the decision be communicated?
  • How will the estate be equalized for the non-successor(s)?

Once the decision has been made and communicated, the job of preparing the successors begins.  Depending on the nature of the industry and on the style of the existing owner, the transition can take weeks, months … and often years.  

Clearly, leaving the succession to chance exposes the business to a level of risk that could result in unintended results, and possibly a total loss of the enterprise.

Preparing the business

The most effective succession plans flow naturally from the existing business.  A seamless ownership transition can be facilitated by conscientious record-keeping, people-independent management systems & policies, and general good organization.

An acid test for the owner is to consider what would happen if that owner were to take an extended vacation for 3 to 6 months, 

  • If the business’ operations are significantly impaired or would grind to a halt (or if the owner gets no sleep while away), it is likely that the only thing to be transferred is a job obligation
  • If the business remains pretty much intact, there is a true business opportunity to be passed along 

To the extent then that the business preparation fundamentals are in place, the time required to transition the business to successors will be minimized, and the chances for success will be maximized.

Preparing the transaction

Essentially the agreement of purchase and sale is a formal legal record of the business decisions that will have already been made during the foregoing preparation stages.

For many owners, there is a certain amount of comfort gained by knowing the general content of such a document.  It covers things such as:

  • Identifying parties, relationships among them and relationship to the business
  • Statement of the transaction subject matter, price determination and payment method 
  • Parties’ representations about themselves and commitments to one another
  • The closing agenda, including conditions, time, place and documents to be delivered
  • General legal provisions to give effect to the agreement

Finally, as with many matters in life and in business, the best laid plans can go for naught without the financial wherewithal to see them through to conclusion.  Whether it is by sinking fund, insurance or a combination of the two, the job of preparing a business for succession is not complete until succession funding is arranged. 

The bottom line

Planning a succession can be the most challenging business task an owner can face, but it need not be a daunting one.  Knowing these fundamental steps can allow an owner to maintain business as usual for now, for retirement, for life and beyond.