How to avoid the cottage's biggest downside (bugs aside)
Tim Cestnick is president and CEO of WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians.
Who uses the cottage?
One of the biggest mistakes families make is to transfer cottage ownership to those who don't use or want the property. You should have a conversation with your heirs to understand how each one feels about using and owning the cottage. This doesn't mean treating heirs unequally (if you leave the cottage to one heir you might equalize the estate by leaving different assets to others), but it should guide who ultimately owns the cottage.
Should you transfer ownership now or later?
You can transfer ownership of the cottage either during your lifetime, or upon death. Transferring the property during your lifetime allows you to see your heirs enjoy the cottage. In addition, any future growth in value after the date of the transfer will not face tax in your hands, but in your heirs' hands, usually many years down the road. There are ways to transfer ownership today while still maintaining a right to use the cottage and, although the transfer is a taxable event, there are generally ways to eliminate or defer the tax. Transferring ownership during your lifetime can also allow you to see firsthand whether your heirs will co-operate in sharing the property, allowing you to provide input into how this should be done more effectively. On the other hand, transferring the property after your death can provide you with more control over the property today and will defer the tax bill, if any, until the latest possible date. As for my family, we're planning to transfer ownership while Carolyn and I are still alive - but not just yet.
Should there be an option to purchase?
If you're going to wait until you're gone to transfer the property, give some thought to giving your heirs the right to purchase the cottage from your estate using their own resources (including other assets you might leave to them upon your death). This will leave the estate whole by replacing the cottage in the estate with cash or other assets, allowing those heirs who don't want the cottage to receive other assets instead. You'll need to give some thought as to how the cottage will be valued for a purchase (three independent valuations can be provided by real estate brokers familiar with the area and the middle valuation might be chosen, for example). This idea forces your heirs to think about whether they want the cottage because they'll be paying for it. If more than one wants to purchase, they'll have to agree on the terms of sharing the property (which can be a challenge; one owner is always easiest. If sharing is likely, you may want to explore with your heirs today what that might look like when you're gone).
Should the property be held in trust?
If you're simply going to gift the cottage to your heirs (either today or when you're gone) you might think about placing the cottage in a trust. This will make the most sense when more than one heir wants the cottage, you're also leaving cash to your heirs to help finance the maintenance costs, and you're concerned about protecting the cottage from potential creditors of your heirs. The trust can function as an effective governance vehicle to facilitate sharing of the property. On the 21st anniversary of the trust, however, the trust will be deemed to have sold the cottage at fair market value unless steps are taken to avoid this (most commonly the cottage would be distributed to the heirs directly at that time, but other options exist).
How will costs of upkeep be funded and shared?
If you gift the cottage to your heirs, how will they fund the maintenance costs? Can they all afford it? If not, think about leaving sufficient assets to cover these costs. Perhaps a life insurance policy on your life can provide the cash.
More on this topic next week.