Handing down the family cottage

The question of cottages has risen in importance lately because of the effect the recession is having on values, according to Elaine Blades, senior product manager of estate and trust services at Scotia Private Client Group. "Right now, we are seeing more people taking advantage of depressed prices to buy one. Current owners are actively considering transferring title because lower values mean tax savings in the future," she says.

But the summer cottage that brought so much pleasure to the family may turn into a financial issue for the next generation, Ms. Blades warns.

Taking the time now to plan how to turn the property over to the next generation -- whether you own or are just in the process of purchasing -- could help manage tax and other implications.

"Passing on family cottages has become a real area of concern for many Canadians," she says. "A good many people don't understand or have never thought of the capital gains taxes and other expenses it can trigger.

"Given the dramatic appreciation in the market value of cottage properties in this decade -- even in the light of the current recession-- the capital gains taxes that must be paid can often prove so great the property must be sold to pay them."

In a nutshell, unless the principal residence exemption can be used or the property is passed to a spouse, cottage succession triggers capital gains no matter how it is done. Sometimes there isn't actually a "sale" of the cottage, but rather a transfer of title that triggers the capital gain. In these situations, the disposition is considered to have occurred at fair market value. The capital gain is calculated by deducting the adjusted cost base from the current market value of the property. The adjusted cost base is generally the purchase price, or the value in 1972 if the property was bought before that date, plus the cost of certain improvements.

Divide the result by 50% and the seller or transferor includes the amount as income and faces taxes based on whatever his or her marginal rate would be in that year. "It can come as a terrible shock if families are not aware of what will happen," Ms. Blades says. "Fortunately, we are able to tailor options for our clients to mitigate or minimize that tax obligation and even to arrange estates so that the tax is covered by insurance strategies."

The process starts with a relationship manager from Scotia Private Client Group sitting down, preferably with the entire family, or at least family members representing those who have a stake in the future of the cottage, Ms. Blades explains. The advisor's role is to be proactive, to identify and raise all the personal and financial issues that may affect a future disposition based on a clear understanding of the family's total financial picture.

"Mom and dad often go into the discussion assuming all the children will want a stake in the property," she says. "As often happens, however, some do and some really are just not interested. Sometimes children realize they are simply not in a position, personally or geographically, to make use of the cottage."

Then there is the question of whether those who do want the cottage are in a position to afford the property, Ms. Blades says. In addition, parents who want to be fair and equitable in the treatment of their children must decide what to do for those who are not interested in the cottage to balance off the value of what those who are will receive.

As part of the estate planning process, cottage owners can decide to pass on ownership before death or as part of their estate. "Lifetime transfer options include transferring the cottage to a trust, adding the children as joint tenants, gifting or selling the cottage to the next generation," Ms. Blades says.

If older than 65, the parents may wish to consider transferring the cottage to an alter ego or joint partner trust.

Transfers options under the will include outright gifts, transfer to a trust or a sale. If it is a sale, parents may want to give someone the right of first refusal before it goes on the open market, and typically the terms for how the right will be exercised are defined in the will.

Lifetime transfer options trigger capital gains for the parents now. Where only a partial interest is transferred, such as in a transfer to joint tenancy with one of their children, recognition of capital gains in respect of the remaining share is deferred until the parents' deaths.

The transfer may also attract provincial land transfer tax. A key benefit to lifetime transfers is the avoidance of probate fees in respect of the property, which are often a significant concern in provinces with high probate fee rates.

Each option must be looked at on a cost-benefit basis while considering other soft issues such as continuing access, potential creditor or marital concerns on the part of the transferee and even some measure of control of the property during the remainder of the parents' lives if ownership is to be passed on before death.

"A written tenancy agreement setting out the parties' rights to use the property, along with terms addressing such issues as cost sharing, control and decision-making may also be recommended," Ms. Blades says.

If the decision is made to transfer ownership through the will, life insurance strategies can play a major role in greatly easing the tax burden, Ms. Blades says.

"They might even consider taking out a policy large enough to not only pay the taxes but also to have enough left over to help with annual operating costs," she says.

"It all depends on family circumstances. The overall goal is to have no surprises and to make the transfer as easy as possible," she adds.

(Source: National Post)