As boomers approach the age of 60, a significant amount of their wealth is being invested in recreational properties. Cottages that are being built today no longer resemble grandpa’s cabin in the woods from the ’50s. For many people, today’s cottage is a second year-round residence with full services for hydro, heat, telephone, water and, of course, indoor plumbing. Given these modern amenities, the cottage of today has become a significant asset in the family portfolio.
It does not matter whether the cottage you own has been in the family for many years or whether you have recently constructed your own cottage. The fair market value of waterfront properties has increased because underlying land values are based in part upon proximity to the city. Land within a three-hour drive of the city is at a premium, and your cottage’s value may have increased significantly without regard to the amenities that are available.
It’s pretty safe to say that selling your cottage may have capital gains tax consequences. A number of options are available to you and will involve having to choose the years during which you wish to designate your house or your cottage as your principal residence.The Income Tax Act states that your family can have only one capital gains tax-free principal residence in any taxation year.
If you own more than one residence, you will have to choose which one and for what number of years you wish to designate it as your principal residence. Take, for example, the situation where your house has grown in value but your cottage value has stagnated because you still have many improvements that you want to make to it. When the time comes to sell your house, you will designate your house as the capital gains tax-free principal residence.Then the clock will start running on your cottage so that going forward you may be able to designate your cottage as your capital gains tax-free residence. If the situation were reversed, you could designate a period of years when your cottage was your principal residence so as to spread the tax burden between the two properties (see the sidebar for an example of a capital gains calculation for your cottage).
You may not wish to sell the cottage at all but pass it on to your children either before or after your death. The future ownership and management of the family cottage requires careful thought. You may leave the cottage in your will to all of your children jointly and hope that they will be able to sort out among themselves how they are going to share recreational time as well as the workload that follows from season to season in keeping up a rural residence year-round. Certain obvious expenses also have to be shared, such as property taxes, heat, hydro and insurance.
Many factors will affect your children’s willingness to undertake a sharing of these burdens. One of the alternatives you may wish to consider is to provide in your will that your cottage will be sold but give the right to any of your children to buy the cottage for its market value from your estate.The ability to do this will depend on how much is available to each of your children from the remainder of the estate as well as their personal resources.
This does not answer the question of what will happen if more than one child wants to purchase the cottage or what will happen if the child who can really make use of the cottage does not have enough money to purchase it. Despite your best intentions, you may not be able to match the needs, wishes and financial abilities of your children in trying to pass your cottage on to the next generation.
Perhaps the most practical solution is simply to ask your children who will want the cottage after you are gone. This often resolves the issue quickly because some of the children will reside at such great distances that they will really have no interest in continuing to own an asset to which they have infrequent access. Even children who are closer to home may have little or no interest in cottage life.
Determining the answer to these questions for yourself will enable you to develop a useful plan for the children who are interested in having the cottage. No matter who ultimately gets the cottage, it is usually possible to adjust the shares of your estate to balance things out with the other children.
Whether you have a mansion in the Muskoka’s or a summer residence in a mosquito theme park, every member of your family will have a sentimental attachment to it. By asking them directly, you can better balance their needs, wishes and financial abilities.
Keep in mind that one of the reasons that your children may be so enamoured of the place is that you have paid all of the bills and maintained the cottage for them free of charge. You will need to discuss these issues with your children frankly, to determine whether your property will be properly maintained as you have always done.
The probate issue
People who reside close to a provincial border have to remember that if the cottage is in another province, the devolution of that property through probate will have to take place in that province. For example, property located in the province of Québec will have to be probated in that province in order to effect a transfer from your estate. Probate fees in Québec are significantly lower than in Ontario, but your remaining assets still have to probated in Ontario if you die in Ontario.
Before commencing any probate proceedings in Québec, you have to complete the process in Ontario and then do it again to deal with the property located there.
Once you know which child will ultimately receive the cottage as part of their legacy, you might consider as you get older making the transfer of the cottage to that child to avoid some of the probate problems following death.This will also allow you to make the adjustment within your estate to compensate the other children who were not interested in the cottage.
Transferring ownership of your cottage in this manner requires a cautionary note. You may wish to make an agreement with your child to ensure that you will be able to go to the cottage at any time as you have in the past, despite the fact that you no longer have any proprietary interest. If you detect any reluctance to discuss the cottage among your children, threatening to sell it outright will usually get their attention — enabling you to gather the information that you need to make your decision.
NOTE TO READERS:This article is for information purposes only. Please consult your lawyer before taking action on information provided in this article.
John Johnston is a partner with the law firm of Nelligan O’Brien Payne LLP (www.nelligan.ca) with offices in Ottawa, Kingston, Vankleek Hill and Alexandria.
[This article was originally published in the July/August 2005 issue of Fifty-Five Plus Magazine.]
Calculating Capital Gains
If you bought your cottage in 1990 and proposed to sell it in 2010 and the increase in the fair market value over that period of time was estimated to be $100,000, then you would use the following formula:
1 + the number of years designated as principal residence (5) = 6
divided by the number of years ownership (20) = 0.3
x the capital gain ($100,000.00) = $30,000.00
(the amount of capital gain that is exempt from taxation)
If you have invested a significant amount of money in improving your city home or your cottage, then this may have the effect of raising your adjusted cost base for that property — thus decreasing your capital gain.
If your mind is reeling from the arithmetic — as mine is — you probably should not try this yourself. An accountant should be able to assist you in making the right decision about designating your principal residence.