If you own property in cottage country, you already know spending summers by a tranquil lake is the stuff Canadian dreams are made of. Thanks to a booming real estate market, your cottage may also be one of your family’s biggest assets. And yet passing it to the next generation could prove more complicated than you might think. Chris Gandhu, High Net Worth Planner with TD Wealth, joins Kim Parlee for a three-part series on cottage succession. In part one: Some ways to purchase a cottage that could make an eventual transfer more successful.
Now let's start with a little perspective. The average price of a cottage in Muskoka, which is an area in Ontario, is now around $1 and 1/2 million. We've seen prices soar there like we've seen prices soar right across the country. So that asset you have as a cottage is becoming even more valuable, and passing it down can be complex. So that's what we're going to be talking about the entire show.
And we're going to start things off with a story about Jeff. He's been thinking about passing down his family cottage since he bought it back in 1999.
Come on over. Come on over. One of my grandsons is here. Max, come over, come. They just went strawberry picking. Oh you want me to take a... OK.
See? That's what we have to deal with.
[SOFT MUSIC PLAYING]
That's beautiful strawberries you got there, Max.
We bought the cottage in August of 1999. And it had always been a dream of mine. Our cottage is a typical cottage-style cottage, wood paneled on the inside. And we are on Lake Simcoe, which is about an hour's drive north of Toronto, which is terrific because people can come for the day and then leave. They don't actually have to stay over.
We are on one of the most beautiful sandy beach areas of Lake Simcoe. It's a very deep bay, and we're right in the center of the bay, where the water is very shallow and where the children could walk in and it's only up to their knees. When I bought this cottage, we were a family of five, with my wife and I, and we had three little kids. Well, fast forward from 1999 to 2021, and my three kids are all married. So, now we've gone from a family of five to a family of 12.
- And we had a fantastic morning with my three-year-old grandson. We went to strawberry fields, we went on a tractor ride, we picked our strawberries. Now we're going to bake something with our strawberries this afternoon. So I think that's what it's all about being at the cottage.
So I have decided to make this an heirloom asset to the family. I want to pass it down to the next generation because I know it would be very hard for the children and grandchildren to replace it at a future date. Passing down a cottage is a lot more complicated than people really think about, particularly when they buy their cottage.
Being a financial planner, a tax guide by background, I was concerned with the rise in the value of the cottage and the income tax implications of death. So when I instructed the lawyer to complete the purchase, I instructed the lawyer to create a trust for the property ownership so that the trust would permit the property to be transferred to the children at the cost base to the trust.
I'm having that discussion with my children now. I'm having the discussion about placing the ownership in the hands of the children, but letting them know that they're going to need some type of co-ownership agreement so that there's agreement amongst themselves, who is responsible for sharing the cost, who's responsible for overseeing the maintenance. Because otherwise, people might sit back and rely on other people who are going to be upset that they are responsible for it, but other people are sharing in the benefits.
All the kids want to be owners. It would make me feel great that they see the cottage as being an important part of their lives going forward, and an important part that they want their children to enjoy and appreciate. So they realize also that we are very lucky, and they want to continue to keep it in the family.
[SOFT MUSIC PLAYING]
- So that was Jeff, and that is his cottage succession story. Here to give us some tips on some of the things we need to be thinking about, one of our favorites, Chris Gandhu. He's a high net worth planner, joining us from Calgary.
Chris, thanks for joining us. It should be, in theory, so easy. Why can't you just put your cottage in the will and pass it on to the kids? Why is it more complicated than that?
- Hi Kim, good to be here. Kim, I mean, of course you can put it in the will, but the question is, should you be putting it in the will? And the reason it's complicated-- and the big reason here is that there's a lot of data that are possibly to be dealt with.
So if you look at Jeff's situation, he bought the cottage for about half a million dollars. And if you assume it's sort of an average cottage in Muskoka, it's worth maybe $1 and 1/2. Now, Jeff holds it in a trust, but if he were to hold it outside the trust, that would mean at the date of death, we're looking at a $1 million capital gain. And we know half of it's tax fee, half of it's taxable income, and half a million in taxable income would lead to about $250,000 in tax. And that is a fair amount of money.
And most estates won't have the liquidity to deal with it. So if there is insufficient liquidity and you haven't planned for it, that actually might trigger a sale of the cottage to pay for the tax bill, thus kiboshing that well laid-out plan of passing on the cottage.
- There's a lot to deal with there, and we're going to be talking about, again, how we manage all of that complication for the show, including the great big tax bill. But let's start things off with-- Jeff is probably, I'd say, the exception to the rule. Most people don't think about this as much as he does, but he's in the business of thinking about this. But when you start by buying a cottage, does it matter how it happens in terms of whose name you put it in?
- It may. I would say most people out there, because of how we own our principal residences, might be buying the cottages outright in their individual names. And typically, a married couple would buy it jointly with a right of survivorship between the names of the husband and wife. So that's something we're familiar with. It is quite common, and it does have some benefits to it.
First, at the time of death, although there is a disposition and a tax may arise, you have the option to perhaps elect and choose the cottage to be your principal residence, not necessarily the house that you spend most of your day-to-day time in. So it's possible that if there is a large gain there, you may shelter it using that exemption. The second option is that if it's jointly owned, you also avoid probate at first death in some provinces like British Columbia and Ontario. There is-- probate planning is a big deal.
Owning it jointly, though, does handcuff you in terms of flexibility. So if it's jointly owned property, we know it bypasses the will and automatically transfers to the surviving joint owner. So if you wanted to do some enhanced will planning, you don't have the flexibility to do that. And sometimes, for foreign properties, especially US properties, it actually can be a negative from a tax perspective.
- Now, Jeff also mentioned when he was talking about how he did it to talk about trusts. I know what people can talk about corporations. So there are other options as well when you're making that purchase.
- Yeah. You see, everything out there, there's a whole bunch of intermediary somebody could use. Corporations you’ll see when somebody has money trapped inside their company and they're perhaps reluctant to pull the money out, pay personal tax on it, so they'd rather just go ahead and buy the cottage where the money is, which is fine, except there are a whole bunch of traps to watch out for.
First, because the corporation owns the asset, not you, if you're going to use it as your cottage vacation property, well, now you've got to pay the company rent for it, fair value rent. And that just means the company has to then report their earnings and pay tax on it. So although you avoided some tax upfront, now you're going to pay tax along the way. If it's an active business that happens to own the cottage, there's some tax issues there. Plus if you want to sell that business, I may want to buy your business but not necessarily your clients, right?
The cottage also potentially exposed to creditors of their business. So there's a whole bunch of traps to watch out for. Jeff, of course, being a tax guide, opted for the route of using a trust to own the cottage.
And all of these issues that we've talked about due to death tax, probate, and perhaps delays to do with estate administration if the property is passing through the will, well, the trust provides you with the flexibility to deal with all of them. So it's not a silver bullet, but it is a planning option, and I know you and I will talk more about that later on.
- All right. Well, there you go. Stay with us. We come back. As Chris mentioned, a lot more to talk about. We talked about some of the ways you can purchase a cottage. When we come back, we're going to talk a bit about selling it, capital gains taxes, how to manage all that. You're watching Moneytalk. We'll be right back.