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Yes, You Can Keep the Family Cottage In The Family

Wooden dock on autumn lakeMillennial Parents’ Guide to Financial Planning by Michael Lampel

The family cottage to many is a sacred treasure. It’s a place, according to parents, that must be preserved for the family. It holds such special moments and memories for everyone; every parent wants to ensure their children and grandchildren will be able to build their own memories at the cottage.

Unfortunately, if the transition from parents and grandparents to next generations isn’t handled just right, it will become the place that holds a lot of bad memories instead.

While most parents want to ensure equality in their estate between all children, the truth is: when it comes to the cottage, this won’t be possible. While all their other assets, including the principle home, can be sold and the proceeds distributed equally among the children tax free, the cottage is the one place where ownership is very difficult to divide equally (if the property won’t be sold and the proceeds shared with everyone).

There are several key points you should be aware of if you want to keep the family cottage in the family.

Unless your parents sold their principal residence and moved into the cottage to list it as their principal residence, the cottage will be considered a second property.This means that, when under their will, the title of ownership of the cottage is transferred to you and your brothers and sisters and the government views it the same as if they sold it.

The transfer of the cottage to you and your siblings is considered a “disposition” or sale. The transfer would result in a “capital gains” tax, or as I call it in plain English, profit tax being applied to your parents final tax return.

Capital Gains or profit taxes are taxes you must pay when you buy something at one price and sell it later at a higher price. Like stocks, second property (cottages) or investment properties.

The capital gains taxes (profit taxes) owing would be calculated and applied to your parents final tax return. The lawyer handling your parents estate is required to file a final tax return before all their assets are liquidated and transferred to those listed in their will. Any final income taxes or capital gains taxes will be paid by your lawyer from the cash proceeds in your parents estate and not from you or your siblings. The transfer of all the assets can’t take place until all taxes owing are paid and the court gives the “all clear” to transfer.

If under their will they opt to transfer the cottage rather than sell it and share the proceeds, then when the cottage title is transferred to you and your brothers and sisters, the lawyer will complete a fair market value assessment. The “FMV” is a report conducted by a local realtor, usually the one estimates the value of the cottage the day of their passing. The FMV is then listed as the market value on the documents at the local registrar’s office as the value when the title is transferred.

To illustrate how this will work:
· Upon your last parent’s passing, the lawyer handling your parents estate will conduct an “FMV” report.
· The FMV will show the value of the cottage. For example, let’s say the cottage is valued at $500,000 and your parents/grandparents bought the cottage in the 1960’s for $25,000.
· When the transfer is completed at the local registrar’s office the value of the sale of the property will be listed as $500,000.
· On your parents final tax return the accountant will set the profit on the cottage at $475,000 ($500,000 – $25,000).

Your parents final taxes owing on the cottage will be based on half the gain of $475,000 or $237,500. In Canada, capital gains taxes (profit taxes) are applied to half of the gains — not the entire amount as if it’s regular income from employment, rental properties or interest. In this example, your parents would be taxed on $237,500. If your parent’s income in the year they passed away was $70,000, for example, then their income tax rate would be 29.65% (30%).

The final taxes that would be owed by your parents (or your family) on the transfer of the cottage to you and your brothers and sisters would be $237,500 *30% = $71,250. This amount would be paid from your parents’ cash proceeds in their estate… unless they don’t have the cash to pay the taxes (and that’s another blog of its own).

So now you have an understanding of the taxes your family would owe just to keep the cottage. In our next and last blog of the summer cottage series we’ll cover how to transfer the cottage and still keep the family happy and intact.

I’ve advised many families on an estate equalization plan when it comes to cottages and other assets. While we all know that over the next 10 years $750 Billion of ASSETS will change hands, your family needs to ask the same question as everyone else: “how”?

If you wish to discuss with your own family, and look at a plan to keep the family happy and intact when the cottage and all the assets start transferring, feel free to contact us.

Sample illustration of Child Plan™ Cash and Insurance Values

Based on a Monthly Deposit of $225 per month

Age Accumulated Cash Value Life Insurance Value
20 $80,448 (Education) $770,802
35 $184,850 (House) $1,070,880
45 $325,714 (Security) $1,343,568
65 $964,321 (Retirement) $2,082,564

Sample illustration is based on a $225 monthly premium for twenty years, starting when the child is less than 1. Cash and life insurance values are based on the current dividend scale of 6.0% from a Canadian Life Insurance Company. This example is strictly for illustrative purposes only, the annual dividend scale is not guaranteed and values may differ.

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*illustrations are reflective of the annual premium amount

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