AccounTrust (post until Sept. 30/19)
Estates & Wills & Trusts

The perils of bequeathing the family cottage

Leaving the family cottage for the next generation to enjoy often sounds like a wonderful idea to parents who want their children and grandchildren to continue making memories, but that’s not an approach Toronto wills and estates lawyer Mary Wahbi recommends lightly.

“Typically, we advise clients to sell it unless they can absolutely negotiate the co-ownership agreement now, while the parents are still around and acting as the glue holding everything together,” Wahbi, a partner with Fogler Rubinoff LLP, tells AdvocateDaily.com.

The co-ownership agreement enables the family to continue using the cottage while clearly spelling out how it will be used, paid for and taken care of, she says, adding the contract can even be included as a failsafe in the will to be imposed as a condition of the gift if the beneficiaries can’t come to an agreement within a specified time after death.

"Part of the gifting in the will can also include a cottage fund aimed at covering the costs for three to five years while the children get their act together," Wahbi says.

The contract would include provisions dealing with who will use the cottage and when, whether on an exclusive or shared basis, contributions for day-to-day and capital expenses, and what happens if one of the family members dies or no longer wants to be involved in the cottage, Wahbi says, suggesting families start a fund for expenses, repairs, capital improvements, opening and closing costs and supplies.

In the absence of an agreement and lines clearly drawn on how the cottage will be managed and shared in a way that satisfies everyone involved, the best approach is to simply sell it, she says.

“Minor things can become major irritants. People can become very upset about these issues and it can cause huge family discord when it could have been addressed ahead of time,” Wahbi says.

She recalls one file she dealt with in which the arguments over the cottage became so difficult that it deteriorated into a disagreement about toilet paper.

Wahbi believes drafting a co-ownership agreement is crucial for those who want the cottage to remain in the family.

“It can be hard to put together that type of agreement, but it’s better to do it ahead of time than to try after people have already developed animosity towards each other,” she says.

While Wahbi says those “softer issues” tend to be the most difficult, there is also the practical consideration of how the cottage will be passed on from one generation to the next, including the tax implications.

“When you gift a property or an asset to your children in your will, they receive it tax-free, but it triggers a tax to your estate,” she says. "That can result in unexpected consequences to the beneficiaries of the residue of the estate which will bear that tax, so careful planning is needed to ensure that the estate is distributed as planned."

An outright gift of the cottage during the parents’ lifetime may also trigger a tax to the parents because they will be deemed to have disposed of the property at its fair market value, Wahbi says.

"There may be ways the parents can shelter that tax, for example, by using their principal residence exemption," she says. "Of course, most parents still want to have the benefit of the cottage during their lifetime so that needs to be addressed.

"One option is to transfer the cottage to a trust during their lifetime and set out the terms of usage and succession in the trust agreement. While the transfer is deemed to occur at fair market value and immediate tax may be triggered, all future growth in value will not be in the parents’ hands and the trust can be a test drive for family sharing," she says.

Wahbi adds that often one child is very connected to the cottage while others are not, and parents may consider selling the cottage to that individual at a discount, with a view to making up the difference to the other kids with cash gifts. 

“If parents decide to transfer the cottage to a family member during their lifetime for less than the fair market value, they are deemed to sell it at fair market value, which may trigger a tax if there is a capital gain in the property,” she says. "This could result in double tax to the family. That’s because the child acquires the cottage at the price paid for it and when it comes time later for them to sell, they end up paying that tax as well, because their cost base is not increased to the fair market value that the parents were taxed on."

By way of example, she points to a cottage the parents purchased for $100,000 that is now worth $600,000. If they transfer it to their children during their lifetime for $100,000, capital gains tax is triggered on that $500,000 difference and half of that is included in the parents’ income, Wahbi says.

At the maximum tax rate, the parents will have to pay about $125,000 in capital gains tax, she says.

“And it’s worse than that because your children’s cost base will be what they paid for it — $100,000," Wahbi says, meaning that they, too, will have to pay tax on that same $500,000 growth in value when it comes time to sell.

“So selling at below fair market value is a very bad idea," she says. “The best idea in this scenario is to sell it to the children at fair market value and avoid the double tax," Wahbi says. The parents can accept payment by promissory notes, which can be forgiven on their death in their wills without tax implications.

Wahbi says there is an unhappy alternative for those who do end up in an unworkable shared cottage situation, which is expensive and doesn’t lead to family harmony.

“The bottom line is if you own property with someone else, and things don’t go well, you have the right to apply to the court for a partition and sale of the property,” she says. "Clearly proper planning is a much better alternative and if that fails, a sale may be the better alternative."

To Read More Mary Wahbi Posts Click Here
Lawyer Directory
New Media Forensics (keep up until June 30, 2019)Toronto Lawyers Association (post to 6.30.19)MKD International (post until Sept. 30/19)Feldstein Family Law (post until May 31/19)Davidson Fraese (post until Sept. 31/19)VR Law/Victoria Romero (post until June 30/19)Ryerson LPPLee & Associates (post until Feb. 28/20)