For many Ontario families, the cottage is more than a piece of real estate. It is a place where families gather, traditions are built and cherished memories are made. Because of the sentimental value that cottage properties hold, they often require special consideration when creating a will or estate plan.
Whether your goal is to keep the cottage in the family, minimize tax implications, or help prevent future family disputes, planning ahead can make a significant difference in managing the future of the property.
What Makes a Cottage Different from Other Properties?
In estate planning, one of the key differences between a cottage and a family home is that a cottage is typically considered a secondary residence rather than a principal residence. This distinction can have important tax implications when the property is sold, gifted, or transferred, including upon the owner’s death.
In addition to tax considerations, cottages often carry significant emotional and sentimental value. It is common for multiple family members to have strong attachments to the property and differing opinions about its future. Without a clear plan, these competing interests can lead to disagreements over ownership, usage and maintenance responsibilities.
Tax Implications
When an individual dies, Canadian tax law generally treats most property, including a cottage, as though it was sold at its fair market value. This is referred to as deemed disposition.
Unless the cottage is transferred to a surviving spouse or common-law partner, any accrued value, or “capital gain” from the property could be taxable. As a result, the deceased owners’ estate may be responsible for paying the resulting taxes before the property is distributed to the beneficiaries.
The capital gain is generally calculated as the difference between the property’s adjusted cost base and its fair market value at the time of the transfer. Under current tax rules, 50% of the capital gain is taxable as income. Depending on how much the property has appreciated in value over the years, this can result in a significant tax liability for the estate and the beneficiaries.
The Principal Residence Exemption & Other Estate Planning Strategies
One Way to reduce or eliminate capital gains tax on a cottage property is through the Principal Residence Exemption. Under this rule, properties designated as a principal residence are not subject to capital gains tax upon disposition.
A cottage can qualify as a principal residence if it was ordinarily inhabited by you and your family members during the year, even if it was only used seasonally. For most families, however, only one property can be designated as their principal residence each tax year. If you own both a home and a cottage, careful planning is required to determine which property should be designated as your principal residence in order to maximize the available exemption.
Other Estate Planning Strategies
There is no one-size-fits-all approach to planning for your cottage in your will. Depending on your goals and your family’s circumstances, several options might be available.
Some cottage owners establish a trust as part of their estate plan. While trusts can provide benefits such as helping manage ownership or protecting beneficiaries, they also involve significant legal and tax considerations.
Another option that some owners consider is making one or more of their children joint owners of the cottage during their lifetime. The intention is to simplify the transfer of the property upon death and/or to reduce estate administration tax and other associated fees.
However, like establishing a trust, joint ownership carries its own legal and tax consequences for both owners and their children. Speaking with a lawyer can help you navigate whether the above strategies may be a good fit for your specific situation.
Cottage Sharing Agreements
Oftentimes, cottage owners hope to leave the property to multiple children or other family members. While it’s ideal to assume that everyone will work together to manage the property, shared ownership can create significant challenges over time. Due to the sentimental nature of cottage properties, shared ownership can often lead to emotionally charged disputes and difficult questions, such as:
- Who gets to use the cottage and when
- How expenses for the cottage will be shared
- Who is responsible for maintenance and repairs on the cottage
- How major decisions, like potential sale of the cottage, will be made
One of the most effective ways to reduce future conflict is through a comprehensive cottage sharing agreement. A cottage sharing agreement establishes clear rules for how the property will be owned, managed, and maintained after it passes to the next generation. Depending on the family’s objectives, the agreement may address:
- Ownership percentages between different family members
- Scheduling and use of the property
- Annual expenses related to the property
- Maintenance responsibilities
- Decision-making responsibilities
- Sale procedures and restrictions on sale
A pre-existing agreement regarding these issues creates a clear roadmap for family members that can help preserve both the cottage and the relationships of the family members who use it. It is possible to prepare a cottage sharing agreement alongside your will, so that in the event ownership is transferred, there are clear rules and guidelines in place to ease the transition.
How a Lawyer Can Help You Plan
Hiring a lawyer to help draft your will and arrange an estate plan for your cottage can help you plan ahead to prevent future disputes. Working together, a lawyer can help evaluate the available options in light of your family’s objectives and your specific wishes for the property.
The content on this post is for information purposes only and is not legal advice, which cannot be given without knowing the facts of a specific situation. You should never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. The use of the website does not establish a solicitor and client relationship.