A family cottage is one of the most difficult assets to deal with when estate planning. There are various planning strategies to consider when it comes to passing a beloved cottage to the next generation. There are numerous issues to address including tax implications, such as capital gains, forced sales, and the practical realities of sharing a cottage. The options below speak to a parent with children but could equally apply to other family compositions.

Option #1: Outright Gift in your Wills

One option is to simply gift the cottage outright and equally to your one or more of your children in your Wills. You would likely want them to take title as ‘tenants in common’ so that each child could pass their share to their own children upon their deaths.

One issue to consider is that one of your children could sell their share to a third party without the consent of your other children. Having said that, it may be practically difficult to sell a one-third interest in a property to a third party. This could be addressed by including a right of first refusal in your Will to provide that should a child wish to sell their share, it would first have to be offered to your other children. Please note that such a clause would only be valid before a child received title to their share i.e., if title was taken and five years after your death, a child wished to sell their share, they would not be bound to sell their share to their sibling(s).Whether at the time of your death or at some later date, difficulty could arise should one or both of your other children not be able to purchase the share of the child wishing to sell. In such a case, it would be possible for the child wishing to sell to seek the court’s consent to a forced sale of the cottage.

One way of addressing the concern of a potential forced sale is to ensure that there are sufficient liquid assets in the estate so as to provide the necessary funds for your other children to purchase the share of a child wishing to sell. One option is to do so through a life insurance policy (discussed more below).

It should be noted that the sale of the cottage property cannot be absolutely prevented in such circumstances as all of your children agreeing that it be sold or there being taxes owing and no other way for your estate to pay them.

Option #2: Option For Child(ren) to Purchase

Another strategy is to give each of your children the option to “purchase” the cottage from your estate. Your Will would set out that each of your children could use some or all of their inheritances to purchase the cottage from the estate at its fair market value.

If two or more of the children chose to exercise the option, they could agree to an equal or unequal ownership depending upon each child’s own family circumstances. A benefit to this option is that it allows each of your children to evaluate their own personal situation at the relevant time and make a decision with respect to an interest in the cottage.

The clause could also be drafted such that, if a child had predeceased you, the option which would have been given to that deceased child could be exercisable by your executor on behalf of the children of the deceased child.

A benefit of this option is that it leaves the sale proceeds of the cottage in your estate and thus available to pay any capital gains taxes that may be owing. If you own more than one real property, it is possible that some amount, a possibly significant amount, of capital gains will be payable upon your death. As such, you need to ensure that will be sufficient liquid assets in your estate so that the capital gains owing can be paid without requiring the sale of the cottage.

Another option is the use of life insurance. The policy would be arranged to be payable on death to your estate or your children and could provide the necessary funds to cover any capital gains taxes owing.

Option #3: A Cottage Trust

A trust can be established to hold the cottage property as well as some funds to be used for its ongoing expenses and maintenance. This could be done during your lifetime by way of an ‘inter vivos’ trust or established pursuant to the terms of your Will (a ‘testamentary’ trust).

If you wanted to explore the option of a trust, there are numerous issues to take into consideration, some of which include the following:

  • A trust of short-term duration following your death (for example three to five years) may offer some time for your children to make decisions regarding their continued ownership and sharing of the cottage.
  • A trust is deemed to have disposed of its capital property every twenty-one (21) years at which any accrued capital gains become payable. This rule can be avoided by transferring the property to the children prior to the twenty-one year anniversary. It could be transferred at the trust’s tax cost thus deferring the capital gains until property actually disposed of by the children. It is important to note that the transfer of the property into an inter vivos trust generally triggers a deemed disposition unless it is a trust of a particular nature such as a spousal or alter ego trust.
  •  If the cottage property is placed in an inter vivos trust, probate fees on the value of the cottage property would not be payable at your death.
  • If the trust elects to claim the principal residence exemption for one or more particular years, your children and their spouses could not designate any other property for those years as their principal residence.

Option #4: Outright Gift While Living

You could also consider gifting the cottage property to your children during your lifetimes while maintaining a ‘life interest’ for yourselves. I confirm that for various reasons this is not an option that you are considering at present.

This means that the children are the legal owners of the cottage but each of you would have a legal right to the use and enjoyment of the cottage during your lifetimes. Some of the issues to be considered would be the loss of control over the property and the exposure of the property to the claims of creditors and spouses of your children.

With all of the above options, if two or all of your children have an ownership interest in the cottage, they should enter into an agreement regarding the shared use, maintenance costs, etc. of the cottage property. Such an agreement can go a long way in avoiding many of the issues that often arise with shared ownership of a cottage property. And, the advice of an experienced tax professional should be obtained to ensure a full understanding of the tax implications of each option being considered.

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