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Cottage Life: Estate planning for your family vacation property


For many Canadians, owning a cottage or vacation property represents a chance to build family memories in an idyllic setting away from everyday stresses. However, cottage ownership is also rife with issues that go well beyond mosquito bites and fighting traffic to and from the city.


Owning a cottage also means strategizing how to treat the asset in your estate plan, including navigating the various ownership, tax and sentimental considerations. Few assets create as much conflict as the family cottage, which is why it’s best to have a well-thought-out plan to try to remove—or at least reduce—potential issues that can come with having what’s supposed to be a pleasurable property.


“From a planning perspective, cottages are one of the stickiest issues. It’s a complex topic filled with emotions,” says Jag Gandhi, vice-president, wealth planning at Gluskin Sheff.


She recommends the owners have an open discussion among all family members before deciding what to do with the asset in their estate plan. For instance, parents need to discuss with their kids whether they want to take over the cottage while the parents are still alive and, if there is more than one adult child, how many of them will be involved.


“You really need to talk it through,” Gandhi says.


For instance, the next generation’s desire to own the cottage can be influenced by the cost of upkeep, the fact that they live in another province or country, their lifestyle needs, or the fact that they could use the capital for other financial needs.


Knowing what the kids want will make the decision easier. In most cases, owners have three main options:


– Gifting the cottage

– Placing it in a trust

– Selling the property


Each option can be considered while the owners are alive, or be included under the terms of the owner’s will. Here we look at each one and the different tax, cost, and emotional implications:


Gift the property


Many cottage owners want to gift the property to their adult children, especially to those who have emotional ties to the property and may want to enjoy it with their own family someday.


Gifting the cottage property while alive is generally considered a good idea if you’re comfortable giving up control over the property, noting that parents could lose all access to the property if the adult children choose, says Mark Skeggs, vice-president of wealth planning at Gluskin.


Gifting the property will also be considered a disposition for tax purposes and could result in taxes owing unless it qualifies for the principal residence exemption and you elect to shelter the gain.

The tax aspect of gifting the property is critical because the taxes owing can be significant depending on how long the parents have owned it

Still, he says there are ways to structure the gifting of the property in a tax-efficient manner and suggests owners speak to a qualified tax professional to determine what works best in their situation.


The cottage owners can also gift the cottage property to one or more adult children under their will, which is a good option if they want to keep control of it while alive and don’t want to deal with the disposition matters during their lifetime.


If the cottage property is gifted under the terms of a will to more than one adult child, Gandhi recommends requiring the children enter into a co-tenancy agreement covering how expenses related to the property will be paid, including taxes and maintenance, and scheduling who can stay in the cottage at what time. It should also cover how joint owners can sell or transfer their portion of the property if they want to down the road or on their death.


“It should be pretty detailed,” Gandhi recommends so that all potential scenarios are covered in relation to the use of the property and direction is given with respect to joint-ownership.


Parents also need to consider if their kids will be able to afford to keep the cottage. If they feel it might be a struggle, and the kids do not have the financial resources, parents may consider setting aside funds under their will to help cover the costs, at least for a few years. This can be done through a life insurance policy or using other assets.


The other issue with gifting the cottage property, while alive or on death, is how to even out the asset value with adult children who don’t want the property. Gandhi says parents can try to equalize between the children in their will through what’s known as a “hotchpot” provision, which takes into consideration amounts already received by the child when calculating the amount they are to receive under the terms of the will.


Create a trust for the cottage


Parents can also consider transferring the cottage property to a trust, either while they’re alive (known as an inter-vivos trust) or under the terms of their will (a testamentary trust).


There are tax considerations for transferring the cottage property during one’s lifetime to a trust, such as paying the tax on the capital gains resulting from such a transfer; however, depending on the age and residency status of the parents they could consider transferring the cottage property to a joint partner trust (“JPT”) on a tax-deferred basis. This would continue to give the parents control over the property during their lifetime. The JPT could benefit the children and grandchildren after the parents have passed away by placing the cottage property into a subsequent trust.


Placing the cottage property into a JPT would trigger capital gains on the death of the second parent; however, the trustees would have 21 years to deal with the cottage property until there is a deemed disposition of the subsequent trust under the JPT. By transferring the cottage property into a JPT, in Ontario, you can also avoid the application of probate tax on the value of the cottage property as the property is removed from the parent’s estate.


The parents could also transfer the cottage property to a cottage trust under the terms of their will where the children and grandchildren can benefit. Again, the trustees would have 21 years from the date of death to deal with the cottage property until there is a deemed disposition of the trust.


Gandhi says that both types of trusts will have to take into consideration how the trust will be funded to pay for the costs and expenses of managing the cottage property.


Putting the cottage property into a trust may also protect the cottage from any legal disputes that may arise such as bankruptcy, liens and divorce for the children or grandchildren.


The deemed disposition of a trust every 21 years, will trigger a tax event, however, “… depending on how the trust is drafted, that disposition doesn’t mean you have to sell the property,” Gandhi says. “You just pay the tax and the trust can continue for another 21 years.”


Sell the cottage


The other option cottage owners have is to sell the property, either before they die or direct their trustees under the terms of their will to sell the property.


“Selling the cottage before you pass away will of course mean your family no longer controls the property, and could trigger an income tax liability if you do not elect to shelter the resulting capital gain with the principal residence exemption,” says Mark Chan, vice-president of wealth planning at Gluskin Sheff.


Chan says a cottage can be designated as a principal residence if it’s “ordinarily inhabited” during each calendar year being claimed, according to the Canada Revenue Agency. However, a family unit, which may include two parents and their minor children, may only designate one property per year as their principal residence (after 1981).


He says owners generally designate the property with the highest annual appreciation as their principal residence, which could be the cottage, given the surge in recreational property prices in the past few years and the COVID-19 pandemic.


The formula for the principal residence exemption also has modified rules for years of ownership prior to 1982 and a provision for one extra year that may be applied towards a property that is not your principal residence. “These considerations would be something you’d be discussing with your tax advisor, just to see what circumstances work best for you,” Chan says.


A tax professional can also help determine the adjusted cost base of a principal residence or a cottage property, including the original purchase price, incidental expenses to purchase the property (i.e., legal fees, realtor commissions) and any capital improvements and additions made since the property was purchased. Since a capital gain or loss is calculated by subtracting the adjusted cost base and outlays and expenses from the property’s proceeds of disposition, a higher adjusted cost base will reduce your income tax exposure.


Cottage owners could also request to have the cottage sold after they die, as part of the terms of their will, and then distribute the proceeds to the beneficiaries alongside other assets.


“It is a useful exercise to estimate the income tax owing on a sale or gift of the cottage property and consider how you will fund the liability. If you anticipate any concerns with respect to liquidity, life insurance can be used to fund the income tax liability,” says Tiffany Harding, vice-president and head of Wealth Planning at Gluskin Sheff.  “Each situation is different and needs to be reviewed on a case by case basis.”


Harding says parents should initiate the conversation about what to do with the cottage sooner rather than later, to try to avoid family disputes in the future. Additional consideration should be given to income tax, estate or inheritance taxes and legal issues that may arise where any family members or the cottage property is located outside of Canada.


“That’s not to say that there still won’t be family disagreements,” Harding says, “but at least by having the conversations, and making the best plan possible for the property, you can significantly reduce them and try to enjoy the place in relative peace.”


* Please note there are references to employees who are no longer with the firm, but were as of the date of publication.

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