Be wary of taxes in cottage estate planning

Cottage values in Ontario have skyrocketed through the COVID-19 pandemic as scores of people fled Toronto for arcadia and demand vastly outstripped supply, however, this could lead to improper estate planning and even litigation down the line.

Paul Shelestowsky, a senior wealth advisor with Meridian Credit Union, told CREW that there are tax implications in virtually every scenario involving cottage successions, and that complicates estate planning, but there are ways to mitigate the severity.

“For a cottage owner, regardless of how they want to pass it along—as a gift or putting it in a trust—there will be tax implications for the owner because this is a capital asset,” he said. “If they gift it, it’s deemed to have been sold at fair market value, so now there could be $100,000-200,000 in capital gains they have triggered on themselves. If it’s gifted, the child wouldn’t face the tax implications, but the parents would be hit with a massive tax bill.

“The other option is they could sell it to the child at fair market value and now, at least, the parents have the means to pay that tax bill, but the challenge with that is how does the child come up with the money to buy it?”

A potential solution is for the cottage to be sold at less than market value, although even that carries the risk of double taxation. Even creating a living trust, says Shelestowsky, would be considered a deemed disposition by the Canada Revenue Agency, but it would most likely avert legal disputes down the road.

“The nice thing with the trust is parents can still control the cottage and they can name the kids as beneficiaries. It does avoid some probate issues like parents passing away. With a trust, parents and children can have control.”

Trusts require separate tax returns, which can be convoluted, so Shelestowsky recommends having a deed of gift because cottages are often the subject of litigation between siblings, with courts usually rejecting gifting and putting the cottages through estates. Trust agreements are additionally necessary to satisfy questions surrounding who has rights to the cottage and when, who will look after maintenance and future development, and whether or not a cottage can be sold to a third party. The agreement also exists to prevent family members from squabbling about the property in question.

“This isn’t a regular capital asset; it’s an asset that has a lot of emotion attached to it and when emotions come into play, at least you’ll have something to fall back on,” said Shelestowsky.

With the surge of cottage purchases in the last year, Shelestowsky anticipates more family rows in the near future, but a lot of that acrimony can be avoided if families openly discuss inheritance instead of making assumptions.

“When trying to do a succession plan for a cottage, make sure everyone is treated equally, meaning if one child doesn’t want it, you still can’t have one child who benefits and the other doesn’t because that could potentially result in a legal dispute down the road.”