Who Should Inherit the Family Cottage

Questions Every Manitoba Family Should Ask

For many Manitoba families, the cottage is more than just a property. It is where children learn to swim, grandkids spend summer weekends and memories are built over many years – sometimes decades. While these cherished retreats create lasting family traditions, they can also create significant financial and estate planning challenges if proper planning is overlooked.

While it is great to get caught up in the generational fun of the cottage, there are some potential planning opportunities that should not be overlooked. Some of these factors are math-based with concerns about capital gains taxes, upkeep costs such as property taxes and utilities, and of course repairs or renovations.

There are also some non-financial issues that can be overlooked with a family cottage.

These include questions such as, who will inherit the cottage? Will the children agree on keeping it or will there be disagreements about selling? If there are multiple families wanting to keep it, how will the time be split between them?

Let’s first focus on the softer financial planning conversations around the long-term plans for the cottage. The first question to ask is always, “What is the plan after you pass away?” Most clients’ initial reaction is, “It goes to the kids.” While this may seem obvious, most clients forget one thing, do your children want the cottage? Some clients are surprised to hear that their children in fact don’t want the cottage at all. While this can be upsetting for sentimental reasons, this does make the planning a lot easier.

Often, children do want to inherit the cottage. This brings us to the next logical question, if there is more than one child, how is this going to be addressed. Again, this is a round table conversation that should happen with your children. Let’s use an example with two children, while this same information holds true for more children. It just gets more complicated if that is the case. The first issue that can come up is that one child wants the cottage and the other child does not. This can be a common situation and can seem difficult to address. This gets into the topic of Estate Equalization. The basic concept is that we use other assets available to even out what each child receives, in this case one will get the cottage and the other will receive other assets to make up the difference. Because estate equalization is highly dependent on family circumstances and available assets, it is important to incorporate it into a broader estate and financial plan.

If there are multiple children who want to continue using the cottage, this is where some family disagreements are harder to solve. This is best addressed through a family meeting and discussing what the usage will look like. This can include arrangements such as every other week, or every other month. There is no best way to address this style of transition as it will be unique to each family. The best thing to avoid is uncertainty and hoping that your children will figure it out on their own. That can be a disaster waiting to happen. If a clear agreement can be made prior, this will help things go more smoothly when you are not around.

Now let’s switch focus to some of the more traditional worries like taxes and ongoing expenses. For many cottage owners, taxes are often a major concern and can sometimes be overwhelming to the point that planning gets put off. Firstly, taxes are only important to worry about if the cottage is staying in the family. If the plan is to sell the cottage, we are less worried about the tax consequences although there are still some mitigation strategies that should be explored.

The biggest worry is if the cottage is being passed to the next generation. This triggers a capital gain at the time the cottage is passed, in most cases at the time of death. This capital gain is roughly what the cottage is worth, minus what you paid for it. There are some things that can affect this number, but let’s not get bogged down in the details. Of this capital gain, 50% is added to your taxable income for the year. This is best illustrated with an example:

If John bought a cottage in 2005 for $200,000 and it is now worth $500,000, the following calculation would occur should John pass away or sell the cottage.

$500,000 - $200,000 = $300,000 capital gain

$300,000 x 50% = $150,000 of income

In these scenarios, the capital gain as shown in the above example can have a large impact on your estate. Some clients then raise the question of selling to their children directly while they are still living. Unfortunately, that does not change the overall tax burden. However it can be a strategy if the property is thought to increase in value substantially in that time frame.

So how do we address this capital gain should we want to keep the cottage in the family? After determining the tax exposure, there are a few options. Transfer the property to your children while living and pay the taxes, reallocate other assets at death such as investments to pay the taxes, or implement insurance to pay the taxes.

The best approach will depend largely on the individual situation. As mentioned earlier, transferring while living can solve the future growth problem, at the cost of tax right now. Reallocating assets at death such as investments can work, but careful consideration is needed. If we are drawing on those investments for retirement, or there isn’t enough to pay the taxes, there could be trouble. This is where some financial projections can help. The final option of life insurance can be simple, although there are premiums that need to be paid, future growth needs to be accounted for, and you need to medically qualify.

Ultimately, the transfer of the cottage to the next generation is unique to every situation. However there are a lot of common themes. At Prairie Wealth, we are dedicated to getting the whole picture and offer both financial and non-financial advice on how to approach these decisions. While at first glance, dealing with a cottage can seem like a complex task, there are often solutions that are not overly complex.