Part 2: Transition – Transferring a cottage to future generations.
A family cottage is, above all, a retreat for much needed rest and relaxation. The tax implications of an uninformed decision to pass a family cottage to future generations can be startling, to say the least.
This is the second of a two-part series intended to help families prepare for a transition challenge which, when managed without the necessary expertise, can lead to family friction or – even worse – a family schism.
Transferring a cottage to future generations
There is, unfortunately, no non-technical way to deal with the issue of transferring a cottage to future generations. It all comes down to trust. No. Not that kind of trust. A legal trust and, when it comes to cottage ownership transfer, there are four of them.
1. Inter Vivos Trusts
An inter vivos trust is created when you transfer your cottage (or any other assets you have) into a trust while you are still alive. The person you appoint trustee then becomes the legal owner of the property and will manage and deal with the trust assets (which would include the cottage) as you have specified in the trust deed, for the benefit of the beneficiaries named in the trust – such as children.
By establishing a trust, you have some control over how the cottage is managed after you pass. This can ensure a transfer that is fair for all of your beneficiaries and avoids or reduces disagreements.
2. Testamentary Trusts
A testamentary trust is established when you die, usually through your Will. In this situation, the cottage is transferred to the trust after your death, according to your (the settlor of the trust) instructions. As with an inter vivos trust, you can establish the terms of the trust to ensure ongoing, equitable treatment for your beneficiaries.
When you transfer an asset such as a cottage into an inter vivos or testamentary trust, it is considered for tax purposes to have been sold at Fair Market Value. This will most likely result in a taxable capital gain. You may be able to use the Principal Residence Exemption (PRE) to reduce or eliminate the tax payable, but this will depend on your particular circumstances. Otherwise, some tax will have to be paid.
3. Maintenance Trusts
Instead of transferring your cottage into a trust, you can transfer the cottage directly to your children and then establish a trust that contains money to pay for the ongoing maintenance of the cottage. This arrangement should avoid many of the problems that can surface when co-owners of a cottage are faced with sharing maintenance costs.
4. Alter Ego & Joint Partner Trusts
Alter ego and joint partner trusts are both a type of inter vivos trust into which you transfer your cottage while you are still alive. An alter ego trust is an inter vivos trust established for your (the cottage owner’s) personal benefit. A joint partner trust is an inter vivos trust for the benefit of you and your spouse or common law partner.
The main advantage of these trusts is that, if they are properly structured, the transfer of the cottage into the trust is not considered a “deemed disposition”, or a sale at its Fair Market Value. This means that you can defer any capital gains on the trust (resulting from the “sale” of the cottage) until your death. There are specific rules regarding these trusts and they should only be established with the help of a qualified professional.
A word about probate
Probate fees are, essentially, death taxes and are applied to the assets in your estate.
One way to avoid probate fees on a cottage is by using an inter vivos trust, since the cottage will not form part of your estate. Probate taxes are generally modest when compared to income taxes, so consider whether establishing a trust to avoid probate fees makes sense in the context of your overall financial plan and objectives.
While trusts are very useful and flexible while planning the transition of a cottage to future generations, it is important that you seek qualified legal and tax counsel before attempting to establish any one of them. Please contact me personally for advice on your cottage ownership and transition challenges:
For further information and advice, please contact Dave Ritcey, Portfolio Manager at The Ritcey Team of ScotiaMcLeod®, a division of Scotia Capital Inc., Tel.: 902.678.0048