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Aug 13, 2021

More than memories: tax considerations in cottage succession planning

Whether you call it a cottage, cabin or chalet, these treasured family retreats are much more than a piece of real estate. In this article, we explore different avenues that a family can take when they are faced with the decision to sell their cottage or keep it for the next generation.

Kim’s more than 25 years in the financial service industry has given him extensive experience with life and living benefits insurance, including expertise with concepts and sales strategies, as well as tax and estate planning considerations.

During the summer months many Canadians are spending more time at the family cottage, or as my wife’s family from Newfoundland calls it, the “cabin out the bay.” Whether you know it as a cottage, cabin or chalet, the time that families spend at these special places of retreat often evokes fond memories of the happy moments created there.


Learning to swim, catching your first fish, smokies and smores cooked over the campfire with stories and songs afterward – these all come flooding to mind whenever that special place is thought of. It’s because of these emotional attachments that the family cottage becomes something more than a piece of real estate, and why it’s a source of anguish when considering whether or not to keep it for the next generation.


Tax considerations

Memories aside, there are often tax and financial planning considerations that need to factor into your decision. For example, there may be a looming tax bill that could result from the capital gain that has arisen from the cottage’s increased value over time. Unlike your principal residence, which current tax rules allow for a tax-free capital gain on sale or disposition, the appreciation in value of your cottage generally attracts capital gain taxation.


If you purchased your cottage prior to February 1994, you would be eligible for a lifetime tax-free capital gains exemption of $100,000. Many who owned cottages at that time made an election to claim a deemed disposition at the fair market value to capture this exemption and set a new higher Adjusted Cost Base (ACB) for their property. For them, only future capital gain from this point forward would be taxable. Unfortunately, if you did not make this election at the time, there is nothing that can be done retroactively at this point.


Planning options

There are several planning options to choose from that may address this potential looming tax bill. As is often the case, an example will help us consider these. The Jones family bought a cottage about 20 years ago. They paid $250,000 for it, thinking it was a lot of money at the time, and today it is worth $1,250,000, resulting in a capital gain of $1,000,000 – of which 50% (or $500,000) is taxable.


The top marginal rate in Alberta is currently 48%, so the anticipated tax owing at current valuation is $240,000. This is the amount of tax that would be payable if the cottage is sold. It is also the amount that would be payable when both Mr. and Mrs. Jones have both passed on, whether the cottage is sold or not, because the CRA deems it to be sold at Fair Market Value (FMV) when the last spouse dies.


There are several planning options that may help the Jones’s deal with this issue:


  • Transfer title to the cottage to the next generation now while Mr. and Mrs. Jones are still alive. The temptation might be to cut the kids a deal and sell them the property for less than fair market value. That would be a mistake because for non-arms-length transactions, the CRA will deem the property to have been disposed of at FMV regardless of the agreed upon price. This means that Mr. and Mrs. Jones will pay capital gains tax on the difference between the FMV and the Adjusted Cost Base (ACB) of the property, even though they did not realize that value on the sale. Meanwhile, the next generation will have an ACB based on the price they paid for the property. The net result is that when the next generation sells, there will be double taxation.

  • Begin a Sinking Fund. Mr. and Mrs. Jones could begin putting away money now so that there might be enough cash in the estate to pay the anticipated tax on the deemed disposition of the cottage. In order to save for and grow the investment large enough to cover the $240,000 of anticipated tax, they may have to earn considerably more due to tax on investment income and growth. Additionally, this may require the Jones’s to take greater market and interest rate risk.

  • If the family home is sold, be strategic about which property to designate as the principal residence. If Mr. and Mrs. Jones were to sell their home, they would have a choice to make. The CRA permits Canadians to elect which property will be considered their principal residence provided it is “ordinarily inhabited during the year.” Inhabiting the cottage for just a few weeks of the year will qualify it for consideration for principal residence status. If the cottage has appreciated more than the home, then it would be prudent to designate the cottage as the principal residence, thereby reducing the capital gain tax that would be applied.


  • Sell the cottage. Sadly, many families do not have the opportunity to pass on the cottage. Too often there’s a lack of liquidity in the estate to be able to pay the capital gains tax due on the deemed disposition of that treasured property.


  • Transfer the cottage to a trust. Mr. and Mrs. Jones may transfer the cottage to a trust either while they’re alive (called an inter vivos trust) or upon their death through the will (called a testamentary trust).


  • Inter vivos trusts: The person appointed as trustee of an inter vivos trust becomes the legal owner of the property and is responsible for the care and maintenance of the trust assets for the benefit of trust beneficiaries, as specified in the trust document. Mr. and Mrs. Jones may name themselves as both trustees and beneficiaries. Hence, an inter vivos trust provides control and access to Mr. and Mrs. Jones while they’re still alive. It also provides direction as to what happens to the property when Mr. and Mrs. Jones are gone. Establishing the trust is usually a deemed disposition of the property and will result in capital gains tax.
  • Alter ego and joint partner trusts: Alter ego and joint partner trusts are each a type of inter vivos trust created by a settlor who is at least 65 years old. An alter ego trust is one that’s established for the settlor’s own benefit, while a joint partner trust is established for the benefit of both the settlor and his or her spouse or common law partner.

    A significant advantage of these trusts is that, if done properly, there’s no deemed disposition and resulting capital gain tax to pay when the cottage is transferred into the trust. This allows a deferral of the capital gains tax until the death of the last spouse.

    Another important feature of ego and joint partner trusts is that, unlike other types of inter vivos trusts, these trusts are not subject to the 21-year deemed disposition rule. Generally, inter vivos trusts are deemed to have disposed of their property at fair market value every 21 years. The intent of this rule is to prevent the accrual of substantial unrealized capital gains within a trust over a long period of time.

    The first deemed disposition date for an alter ego trust is the date on which the settlor dies. The first deemed disposition date for a joint partner trust is the date of death of the last to die of the settlor and their spouse, regardless of whether these dates occur before or after the 21st anniversary of the trust.

    Mr. and Mrs. Jones may wish to consider using either of these types of trusts in the following circumstances:
    - They own assets of significant value in a jurisdiction where these assets are subject to a high rate of probate tax
    - They own significant assets in multiple jurisdictions
    - If Mr. and Mrs. Jones are in a second marriage and the cottage was owned by one of them prior to the marriage, the original owner of the cottage may want to provide their spouse access to it during their lifetime, but wish to leave the cottage to their own children after their spouse’s death.

    Alter ego and joint partner trusts may be less attractive to Mr. and Mrs. Jones in the following circumstances:
    - The cottage has nominal value
    - They live in a jurisdiction with no or minimal probate tax, such as Alberta

    Testamentary trusts: In the case of the testamentary trust established in the will, the trust beneficiaries are identified and rules and conditions regarding access to and maintenance of the property can be spelled out. Of course, prior to transfer to the beneficiaries, a deemed disposition at FMV will have occurred giving rise to capital gains tax.


  • Transfer the cottage directly to the children and establish a maintenance trust. Mr. and Mrs. Jones may establish in their will that when the last spouse dies, title to the cottage is passed directly to their children. The will may also direct for the establishment of a testamentary trust with enough funds to adequately address the ongoing maintenance of the cottage. This may help alleviate some of the problems that can sometimes arise when multiple co-owners are faced with paying for shared maintenance costs.


  • Use the cottage as collateral for a loan to fund the tax owing. When Mr. and Mrs. Jones have both passed away, the cottage will be deemed sold at FMV and the capital gains tax will be payable. If the estate lacks the liquidity to fund the tax, one of the options is for the estate to collaterally assign the property to obtain a loan in order to pay it. Of course, this means the estate will have to pay the tax plus interest on the tax.

    Further, the interest on this loan will not be tax deductible. There are risks involved with this strategy. What will interest rates be at the time the loan is required? Will lenders be willing to loan? What will the terms be? Can the next generation fund the loan repayment? Will the next generation be able to reach an agreeable arrangement regarding loan repayment?


  • Life insurance. Unlike borrowing to fund the tax where it costs more than the tax itself because of interest on the loan being paid, life insurance is a solution that is much more cost effective. The most efficient way for Mr. and Mrs. Jones to use life insurance is to buy a joint-last-to-die permanent policy. If they anticipate a growing tax bill, a whole life policy with a growing death benefit might be the answer.

    If the property is unlikely to appreciate much in the future, a term to 100 or minimum funded universal life policy will cost less than a whole life policy but will not provide a growing death benefit. In either case, the amount spent to cover the anticipated tax will be less than the tax, itself.

    A joint-last-to-die policy has the advantage of requiring a lower investment of capital than a single life policy, and the death benefit appears at the moment it is needed because it does not pay a benefit until the second spouse dies. This is exactly when the tax bill appears. This provides the estate with the liquidity required to pay the capital gain tax on the cottage, which permits it to pass intact and unencumbered by debt to the next generation.

    Life insurance may also be the best solution in situations where some of the next generation want the cottage and others do not. The death benefit can be arranged to be large enough to provide funds for a maintenance trust or to even equalize the estate so that those not sharing in the cottage are not disinherited. This can go a long way to maintaining family harmony when Mr. and Mrs. Jones have passed on.

    It may be that Mr. and Mrs. Jones do not have the funds to pay insurance premiums, but perhaps their children can and would be willing to do so. After all, they are the ones that will benefit from it.


  • Consider donating the cottage. If Mr. and Mrs. Jones have philanthropic interests, they may want to consider selling the cottage and donating the proceeds to a charity within 30 days of the sale. This would eliminate the capital gains tax on the cottage. In addition, Mr. and Mrs. Jones will be able to claim a large charitable tax credit.


While the memories and emotions that surround your family cottage can make it difficult to decide what your succession plan should be, you also need to be mindful of the tax and planning considerations involved. It is important to have an open discussion with your family to determine who wants it, who can and will continue to use it and how ongoing maintenance will be provided and funded. If life insurance is the appropriate solution, you will need to discuss how it will be paid for. At CWB McLean & Partners, our experts can facilitate these conversations and help make the transition go more smoothly, with fewer disappointments or surprises.


This blog is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon as advice. Please contact your lawyer, accountant or other advisor for relevant advice. CWB McLean & Partners takes reasonable steps to provide up-to-date, accurate and reliable information but is not responsible for any errors or omissions contained herein. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by CWB McLean & Partners or any other person as to its accuracy, completeness or correctness. CWB McLean & Partners reserves the right at any time and without notice to change, amend or cease publication of the information. Click here to view the full disclaimer.