Passing Down the Family Cottage

A Tax & Financial Planning Perspective

For many families, the cottage is more than real estate. It is the backdrop for summers, traditions and shared memories. While many owners intend to pass the cottage on to the next generation, doing so can create substantial income tax liabilities if proper planning is not undertaken. Thoughtful succession planning can help preserve family harmony, reduce taxes, and improve the likelihood that the property remains in the family for years to come.

Why cottage planning deserves special attention

Unlike the family home, a cottage often triggers tax, liquidity and fairness questions all at once. In many cases, parents assume the next generation will naturally want to inherit it equally. In practice, that assumption can create strain. One child may live nearby and use it often; another may live across the country or have no interest in sharing ongoing costs.

That is why cottage planning should start with people before paperwork. Before any transfer strategy is chosen, families should talk openly about interest, affordability, fairness and day-to-day responsibility.

• Do the children want the property?
• Can they afford the upkeep, taxes and repairs?
• Will they co-own it harmoniously?
• If not, how will the estate be equalized?

The tax reality: affection does not eliminate capital gains

From a tax standpoint, the cottage is usually a secondary property. That means a capital gain may be realized when it is sold, gifted or deemed disposed of on death. Even when the family intends to keep the property, the estate may still face a real tax bill.

The taxable capital gain is based on the difference between the cottage’s fair market value and its adjusted cost base (ACB). The ACB generally includes the original purchase price, certain purchase costs and eligible capital improvements made over the years. This is why record-keeping matters. Receipts for a new roof, rebuilt dock, major addition, septic work or other capital improvements can help reduce the eventual capital gain. One of the most valuable planning opportunities available to cottage owners is the principal residence exemption (PRE). A taxpayer may designate either their principal home or a cottage as a principal residence for certain years, thereby eliminating or reducing the taxable capital gain for those years. However, only one property per family unit may generally be designated as a principal residence for any given year. Careful analysis is required to maximize the benefit of this exemption.

Tax-Efficient Transfer Strategies

1) Transferring Ownership During Lifetime

In some situations transferring ownership to adult children or adding children on title into joint ownership with the right of survivorship may allow the property to bypass probate upon death *. Adding a child to title generally constitutes a partial disposition for tax purposes and can trigger immediate capital gains tax on the portion transferred. Triggering the gain during lifetime may make sense in certain circumstances, especially in a lower-income year or when parents want certainty of how the property will be transferred during their lifetime. However, parents should also recognize that joint ownership involves surrendering a degree of control over the property and may create future legal or family complications. There may also be future implications to claiming the principal residence exemption if the children already own a home when this option is used.

2) Sale to Children at Fair Market Value

Rather than gifting the cottage, parents may sell it to their children at fair market value. This approach can prevent future tax complications and establish an appropriate tax cost for the next generation. Where payment is received over time, the CRA permits taxpayers to claim a capital gains reserve, which allows for the taxable capital gain to be spread over a period of up to five years. A promissory note can be issued to the children by the parents for all or part of the purchase price. The promissory note can then be forgiven upon death via the parents’ will, preserving the family legacy and minimizing the future tax burden to the children.

3) Using a Family Trust

A family trust can provide flexibility and control while facilitating an eventual transfer to future generations. Trust structures can help manage ownership, establish rules for property use, protect assets from creditor concerns, and potentially avoid probate fees because trust-owned assets do not typically form part of an individual’s estate. However, transferring a cottage to an inter vivos trust generally triggers a deemed disposition at fair market value and the resulting capital gain. In addition, most trusts are subject to a deemed disposition every 21 years, potentially creating further tax liabilities.

For couples aged 65 and older, a joint spousal trust may offer an attractive alternative. Eligible property can typically be transferred to the trust on a tax-deferred basis, with tax deferred until the death of the surviving spouse. An alter ego Trust offers similar tax benefits for single owners over the age of 65. A joint spousal or alter ego trust may also preserve access to the principal residence exemption in appropriate circumstances.

4) Life Insurance to Fund the Tax

Even where tax cannot be avoided, it can often be funded efficiently. Permanent life insurance is commonly used to provide liquidity upon death equal to the anticipated capital gains tax liability. The tax-free insurance proceeds allow beneficiaries to retain ownership of the cottage without being forced to sell the property to pay taxes. Life insurance may also assist in equalizing inheritances where only some children will receive an ownership interest in the cottage.

*Note: Quebec does not allow property to be held with the right of survivorship or charge probate fees.

Final thought

Passing down the family cottage is rarely just a tax decision. It is a legacy decision. The most successful plans are the ones that combine emotional honesty with practical structure.

The following is a summary of the potential planning strategies and tax implications discussed above:

When families plan early, a range of planning opportunities exist, including strategic use of the principal residence exemption, capital gains reserves, promissory-note arrangements, trusts, joint ownership structures, and life insurance funding. The optimal approach depends on the family's objectives, the cottage's accrued gain, and the financial circumstances of both parents and beneficiaries. Early planning with professional tax and legal advisors can substantially reduce costs and improve the likelihood that the cottage remains a lasting family legacy.

It is recommended that clients seek independent advice from a professional advisor on legal and tax-related matters.

Securities-related products and services are offered through Raymond James Ltd. (RJL), regulated by the Canadian Investment Regulatory Organization (CIRO) and a Member of the Canadian Investor Protection Fund. RJL financial/investment advisors are not tax advisors, and we recommend that clients seek independent advice from a professional advisor on tax-related matters. Insurance products and services are offered through Raymond James Financial Planning Ltd., which is not regulated by CIRO and is not a Member of the Canadian Investor Protection Fund. Raymond James Ltd.’s trust services are offered by Solus Trust Company (“STC”). STC is an affiliate of Raymond James Ltd. and provides trust services across Canada. STC is not a Member of the Canadian Investor Protection Fund.