You might not have known you were creating a family tradition when you first purchased your family cottage. But now, with so many memories packed between the walls, you can't imagine the house belonging to anyone else.
It's true. Passing down a family cottage is more than just turning over a property. It is the gift that is full of sentimental value. Unfortunately, transferring the property to beneficiaries can also come with tax complications and charged emotions between family members.
Here's how to pass down your cottage with as much peace as possible.
Cottage Succession Planning Should be a Group Session
Don't make any family cottage decisions without your family being involved and informed. The succession planning sessions should include all the interested parties. These meetings will establish:
- The Executor and the beneficiaries
- The costs of keeping the cottage and how cost responsibilities are to be split
- The rules of the cottage and usage
- How to decide decisions, such as improvements, and how to settle arguments
It’s key that everyone who might inherit the cottage understands the cost and weight of responsibility that is being passed down to them ahead of time. This way, anyone that isn’t interested in having a part of the family cottage can be excluded from the will. This spares them the tax and spares the others from jumping through legal hoops of selling an uninterested sibling's share.
Transferring the Cottage to a Spouse
If the property is inherited by a spouse, there are no immediate tax consequences following the transfer; the property is considered to be transferred at its adjusted cost base. The adjusted cost base is usually the original purchase price of a property plus all expenses related to acquire it, such as commissions and legal fees. As well any capital improvements made to the property will also be added to the adjusted cost base.
This rule stays true for individuals who remarry later in life, as well. Transferring a family cottage to a second spouse can be a strategy to temporarily put off paying the tax bill.
For example, Lisa Smith, 65, has two children, Jill, 35, and Thomas, 37. Lisa purchased a cottage after her divorce at age 45 for $100,000. Lisa then remarried at age 60, and made her current husband, David, the beneficiary of the property, knowing he would honour her wishes to pass it down to Jill and Thomas when he dies.
If Lisa died unexpectedly at age 65 and her cottage was worth $300,000, the capital gain of the property would be $200,000, with a taxable capital gain of $100,000 ($200,000 x 50%). Assuming a marginal tax rate of 45%, the Executor of Lisa's estate will be responsible for a tax bill of approximately $45,000 ($100,000 X 45%). At this time, if the heirs of this property were Lisa's children, they would have to come up with $22,500 each in tax payments through their own finances or through selling part of their inherited assets. This is an unexpected burden for two people in their mid-thirties who most likely have other financial concerns, like around raising a family and paying off student debt.
By Lisa transferring the property to David, her children can continue to enjoy the family cottage without an immediate tax worry. They also know it is time to start saving for a large tax bill.
Reducing the Tax Burden on Your Children
In our example, Lisa didn’t have to pass down her property to her husband in her will. Yes, it reduced the tax burden temporarily, but the problem doesn’t go away. Her children might inherit the cottage when the property is worth more, making their capital gain and tax bill higher.
Alternatively, the family cottage can be transferred to your children while you are still living, especially if the value of your property will appreciate significantly in the future. You can gift them the property or make them joint owners. It is worth noting that this move will trigger capital gains if the fair market value of the cottage at the date of transfer exceeds its adjusted cost base.
There are other solutions for reducing the tax bill for your children. One popular option is to have permanent life insurance in place with your estate as the beneficiary. This would allow your death benefit to pay estate taxes. The more valuable your property, the higher your life insurance policy needs to be.
Pass Down Memories, Not Financial Stress
Family cottage are a beautiful way to preserve cherished traditions. There are several strategies to make your cottage succession planning more successful. Talk with your financial advisor about the best way to transfer your family cottage down without the stress.