There’s no one-size-fits-all solution. “Planning has a lot of moving pieces, and it’s very important to get it right, and it’s very easy to get wrong,” says Peter Lillico, partner at Lillico Bazuk Galloway Halka Law firm in Peterborough, Ont. He is also a speaker at the Cottage Life shows. “Every family is unique, every cottage is unique, and every cottage succession is unique.” Here, he breaks down the common misconceptions Canadians have about estate planning around the family cottage.
Myths around cottage succession
Identifying any potential issues is the first step in navigating how to transition the family cottage effectively. Let’s look at some common misconceptions and the solutions that work.
1. Assuming everybody will get along
Many parents assume that their children and other family members will agree on how to use and maintain the cottage. This is a mistake because it overlooks the potential for conflicts and differing expectations.
For example, take a family with two adult children, one living in Alberta and the other in Ontario. The one who lives close to the cottage in Ontario may use the property quite often. However, if the expenses are split 50/50 between both, this can lead to arguments. Lillico says: “There are cottage sharing agreements that can, and should, be worked out beforehand.” Parents (and/or their adult children, frankly) can create agreements that outline rules around care and expenses, and whether they should be shared equally or allocated in proportion to usage, or whatever the family wants.
A cottage sharing agreement is a binding document that passes the ownership and control from one generation to the next. It doesn’t just include estate planning details, but also future rules around the cottage. It contains structured instructions for financial responsibilities, sharing usage concerns, division of ongoing labour and maintenance, and even dispute resolution. Lillico explains a real estate lawyer can help with the cottage sharing agreement, as well as “a worksheet that helps [parents] to consider how well suited the kids are for cottage ownership.”
2. Underestimating capital gains tax
Some Canadian cottage owners may believe that succession of the property will leave their children with a valuable asset, but many underestimate the costs of capital gains tax and unforeseen maintenance expenses.
As real estate prices increased over the years, the family cottage may have risen in value significantly, especially if it was purchased decades ago. This leaves owners facing capital gains tax when they sell the property. Capital gains tax is levied on the profit of the cottage, which is considered a capital asset.
Capital gains and losses are calculated based on the difference between the selling price and the original purchase price, adjusted for certain eligible expenses like renovations and improvements. (So, keep those receipts to lower the gain!)
A loss can be used to reduce owed taxes on a personal income tax return. A gain, however, is taxed, but not all of it. The taxable portion of a gain is divided in half, and that amount is added to the individual’s overall income and taxed according to their income tax bracket.