How to Transfer the Family Cottage: Common Ownership Options
October 24, 2024
Much like the decision for when to transfer, each option for how to transfer has pros and cons. To help, we’ve compiled some common options to consider when transferring the family cottage to the next generation.
Chris Hanley, CA, CPA, CFP® and Denika Heaton, BBA, JD, TEP
Mawer Tax and Estate Planning Specialists
Owning a family cottage can be a source of pride and joy, but things can get complicated when it’s time to transfer ownership. Much like the decision for when to transfer, each option for how to transfer has pros and cons. For example, joint ownership can simplify the transfer process, but disagreements over how to use or maintain the property are common. Setting up a trust, meanwhile, can offer a clear structure for managing the cottage according to your wishes, but often comes with added costs and complexity.
It’s important when exploring various ownership structures to understand how each one can potentially impact your family’s situation. To help, we’ve compiled some common options to consider when transferring the family cottage to the next generation.
Please note the following discussion is general in nature. This type of planning involves nuanced tax and legal considerations, so it’s best to consult your legal counsel for guidance on your particular circumstances.
Joint Ownership
Your children can hold the family cottage as joint owners either through a sale, a gift during your lifetime, or as specified in the terms of your Will after your passing. Legal title to assets can be held either as “tenants in common” or as “joint tenants with rights of survivorship.” Each arrangement has distinct legal implications.
Tenants in common
Each tenant in common (owner) holds an undivided interest in the property. This means that each owner has a specific share of the property, which can be equal or unequal.
Upon the death of a tenant in common, their interest in the property does not automatically transfer to the surviving co-owners; instead, it passes to the deceased's estate and is distributed according to their Will or the laws of intestacy if there is no Will. It would be uncommon for spouses to hold property this way as the property would pass through their estate and be subject to probate costs and delays.
Joint tenants with rights of survivorship
Joint tenancy means that two or more people own the same property together, where each joint tenant has an identical interest in the property. This means no single owner has the right to exclusive possession or use of the property; instead, each owner shares the property equally. Each owner’s interest is the same as all other owners, so you cannot have different proportional shares with joint tenancy.
The primary feature of joint tenancy is the right of survivorship. When one joint tenant dies, their interest automatically transfers to the surviving joint tenants, enlarging the surviving joint owner’s shares in that asset and bypassing the deceased's estate. This is the most common way for spouses to hold joint property. However, if joint tenancy is used between siblings, this approach could disinherit the deceased owner’s children.
⟰ The most favoured approach for joint assets to be owned by siblings is tenants in common as it’s an easier way for the family cottage to be held by the next generation.
Cottage Co-Ownership Agreements
If you decide to jointly own the family cottage with your children, then a cottage co-ownership agreement should be executed in advance among all owners. Here are some key considerations:
Establish Governance Parameters
Co-ownership agreements can help govern various aspects such as handling expenses, making decisions on improvements, and addressing what happens if a co-owner wants out or passes away.
Determine Likely Use
Consider everyone’s access and intention to use the property (both now and in the future) and develop a plan to maintain fairness.
Set a Schedule
Establish clear agreements on property use, maintenance responsibilities, guest policies, and financial contributions to prevent conflicts and misunderstandings.
Manage Conflict
Implementing conflict resolution mechanisms, such as mediation or a family council, can address disputes and encourage open communication among family members.
Ensure Continuity
Consider including future generations in the ownership and use of the cottage. Setting guidelines for passing down ownership and involving younger family members in maintenance, planning, and decision-making can foster a sense of ownership and secure continuity.
Include Legal Considerations
Ensure your children’s Wills and estate plans reflect the succession plan for the cottage. Draft legal agreements outlining ownership, usage, and maintenance terms to prevent disputes. Seek family law advice to protect the property from spousal claims and other creditors. Matrimonial and spousal rights may override the co-ownership agreement if planning and caution are not exercised.
⟰ In our experience, transferring the family cottage to some but not all of your children can also create unexpected challenges. While a co-ownership agreement can help address many operational details such as sharing arrangements, access, funding expenses, buy-out provisions, etc., it often falls short in addressing deeper conflicts, especially when communication or long-standing sibling dynamics come into play.
For more considerations regarding cottage co-ownership agreements, please see our ‘Practical Considerations’ checklist.
Trust Structures
A trust is a relationship involving a settlor, trustee(s), and the beneficiaries. The settlor transfers property to the trustee(s) to be held for the benefit of the beneficiaries. A trust can be created during your lifetime (an inter vivos—or living—trust) or upon your passing (a testamentary trust).
A trust can provide control and can help ensure that the settlor’s wishes are followed by the trustees. As well, a trust may help minimize animosity and friction among the beneficiaries.
However, these benefits come with additional costs such as: legal fees to create the trust, as well as the ongoing and often annual tax compliance costs to maintain the trust. Also, when a family cottage is initially transferred to an inter vivos (living) trust, the transferor is generally deemed to have disposed of the property at its fair market value (“FMV”), which may trigger a capital gain.
Common Trust Tax Traps
There are additional tax complexities with a trust, including complex and punitive attribution rules that could apply if the trust is not properly structured.
For example, the 21-year deemed disposition rule requires that a trust is deemed to have disposed of its property for proceeds equal to its FMV every 21 years from the creation of the trust. In other words, every 21 years, the trust must recognize any accrued capital gains on its property as if it had sold the property at its FMV, which includes a family cottage. If the family cottage is to be held for several decades, the cottage held by the trust would be deemed to have a taxable disposition every 21 years, which could generate a large tax liability with no matching influx of funds to cover it.
One common strategy to avoid the deemed disposition is to distribute the property to the trust’s beneficiaries before the 21-year period ends. A trust can distribute property to a beneficiary on a tax-deferred basis, provided certain conditions are met. When you have an asset that is not easily divisible, like a family cottage, it makes this distribution a bit problematic and more complex.
Other Tax Complications Worth Noting
Holding a family cottage in a corporation can lead to significant tax disadvantages, including the inability to claim the principal residence exemption. Further, if corporate property is made available for personal use, a taxable benefit is conferred on the shareholder(s). Holding property in a corporation also involves additional administrative burdens.
Land transfer tax (“LTT”) issues must be considered when transferring a family cottage to the next generation. The LTT applies to all transfers of land, with specific exemptions and reliefs varying by province. The province in which the cottage is situated would have the authority to levy LTT, which, depending on the province (and in some cases additional levies are also applicable by municipalities), can be very substantial.
Lastly, other considerations like the applicability of the Underused Housing Tax Act or any local vacancy levies could impact ownership structure.
Conclusion
Applying an appropriate ownership structure, such as joint ownership or trusts, and establishing clear agreements to prevent conflicts, is essential to ensuring a smooth and equitable transition of the family cottage.
Our Tax and Estate Planning team is ready to assist you with navigating the complexities of property succession planning by working closely with your tax professional and legal counsel to develop a holistic strategy tailored to your family’s unique needs. Please reach out to your Investment Counsellor to ensure your cottage remains a cherished retreat for generations to come.
Disclaimers:
This communication is an overview only and it does not constitute financial, business, legal, tax, investment, or other professional advice or services. It is not intended to be a complete statement of the law or an opinion on any matter. If you (or any of your family members) are a U.S. citizen, hold a U.S. green card, or are otherwise considered a U.S. resident for U.S income/estate tax purposes, the Canadian and/or U.S. tax implications could be substantially different from those outlined herein. No one should act upon the information in this communication as an alternative to legal, financial or tax advice from a qualified professional. No member of Mawer Investment Management Ltd. is liable for any errors or omissions in the content or transmission of this email or accepts any responsibility or liability for loss or damage arising from the receipt or use of this information.
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Mawer Investment Management Ltd. provides this publication for informational purposes only and it is not and should not be construed as professional advice. The information contained in this publication is based on material believed to be reliable at the time of publication and Mawer Investment Management Ltd. cannot guarantee that the information is accurate or complete. Individuals should contact their account representative for professional advice regarding their personal circumstances and/or financial position. This publication does not address tax or trust and estate considerations that may be applicable to an individual’s particular situation. The comments are general in nature and professional advice regarding an individual’s particular tax position should be obtained in respect of any person’s specific circumstances.