The Family Cottage – Dealing with Succession III

We continue with our theme of dealing with the planning process of passing on the family cottage.  We looked at some of the transition strategies available and the implications of each, starting with the timeliest:

1. Give the cottage as a gift
2. Sell the cottage (outright or to a family member)
3. Transfer title into joint name

Now let’s look at some other strategies, some obvious, and some perhaps not.

Transition strategies for the cottage

4. Transfer the cottage to a living trust

A trust such as an alter-ego trust can be created by an individual over age 65 (or for a couple, a similar trust would be a joint partner trust) where assets such as the cottage can be placed.  This type of trust entitles the settlor (the person(s) who set it up) to enjoy and control the assets during their lifetime, and allows a mechanism for those who wish to avoid probate fees or the public disclosure associated with the probate process.

Unlike other trusts, transferring the cottage to an alter-ego trust does not trigger a capital gain.  On the death of the individual (or the second partner in joint partner), the assets such as the cottage are deemed to have been sold at fair market value, postponing any capital gains until then.  The cottage would then be transferred to beneficiaries, outside of the will and free of the probate process.

However, the trust structure requires that capital gains calculated at death be paid at the highest marginal tax rate.  There are legal fees associated with creating the trust, and a separate tax return must be filed each year on behalf of the trust.   

5. Dispose of the cottage through your will

Do you have will that is up-to-date?  Through your will, you can determine how to deal with the cottage at the time of death.  This might be an outright gift to family members or a sale, with family members having first right of refusal.  

This process gives you full control and access while you are living, and the will is easily changed.  In the case where you leave the cottage as a gift, you may have other assets to pay the capital gains.

Capital gains will be applied to the fair market value at the time of death.  This process requires that assets be probated, so there will be probate fees (1.5% in Ontario) and the will is a matter of public record.

6. Keep the cottage until death and fund the tax liability

When considering one of the preceding options, the capital gain will be calculated at death, and paid on the final tax return.   In some cases, there may not be sufficient assets left to pay the tax liability and/or provide equal inheritance to other beneficiaries.  This may result in having to sell the cottage to meet those obligations when you didn’t intend to.  Where might children get the money to pay the tax bill?

A solution to this can be to purchase permanent life insurance to ensure that funds will be available to pay the taxes.   The premium can be paid by you or by the children who would benefit.  

This will provide liquidity to heirs to pay tax liabilities, the benefit will not be subject to probate, and can act as a great equalizer when trying to provide equal shares among beneficiaries.  You must however be reasonably healthy to be able to qualify for the insurance coverage.