Why you should make a proper plan now to avoid struggle for your loved ones in the future
Your cottage is a refuge. It’s a place you go to get away and spend quality time with friends and family without worries, making memories while playing in the lake or relaxing on the deck. But as your children grow up and start families of their own, transferring ownership of this family refuge can be more difficult than you realize.
Keeping the family cottage in the family requires more than a will. Proper estate planning for cottages and other vacation properties requires having a serious conversation with your children about what they want, and another equally important conversation with a financial advisor to make a plan to ensure your family cottage remains a refuge – and not a source of struggle and stress for your loved ones down the road.
Like all estate planning, the best time to start is right now. So, to make sure your family continues to soak up those relaxing days at the cottage for decades more to come, we’ll explore some ways to preemptively deal with possible hurdles when it comes to keeping the cottage in the family.
The cost of not having a proper plan
Considering your own mortality is never fun, but not considering it can be much more unpleasant. If the transfer of your vacation property isn’t properly planned, it could result in the forced sale of the cottage, or in-fighting between siblings as they try to figure out how to pay for the taxes and upkeep.
The main hurdle when transferring ownership
When transferring ownership, the main hurdle families with cottages need to jump is something called Capital Gains Tax or CGT. The CGT requires you pay income tax on 50% of any gains realized from the sale, or in this case transference, of an investment (including all real estate investments). You may not think of your cottage as an investment, but because it’s not your primary residence, the government does.
The answer many people come up with is to sell the cottage cheaply to avoid tax. But that doesn’t work. The CGT is always based on fair market value, so giving the property away doesn’t help anyone. This means if you will your cottage to your child, they will have to pay income tax on half of the increase in value of the family cottage. Sadly, more often than not, cottages are then simply sold to pay off the resulting tax bill.
But money isn’t the only issue when dealing with cottages. Depending on your kids’ plans for the future, one of your children may not want the property or to pay for its upkeep, while others may want to keep it. This imbalance can cause rifts within the family, especially as everyone is most likely feeling very vulnerable.
But with a proper plan, you can make the transfer from one generation to the next less costly and much more simple.
A plan will make your kids’ lives easier
The first step
The first step to smoothing out the transfer of your cottage to your children is sitting down and having a frank discussion. First, make sure your children know how much upkeep is involved, so they can make an educated decision. Then, find out which of your children want to keep the cottage. Too often parents simply assume the desires of their children, and it can lead to heartbreak down the line. If one of your children does not want the cottage, it may be important to you, or that person, to somehow even out the inheritances. Some plans below work well for that, while others don’t.
Now that you’ve had that discussion, you’re ready to make a plan.
Just because your children can’t afford the Capital Gains Tax doesn’t mean your estate must be carved up to pay it. By taking out a life insurance policy that is payable at death, you can ensure your grown children will be able to afford to pay the CGT. A life insurance policy also has the benefit of flexibility. If you are concerned about creating balance in your estate, a child who doesn’t want the family cottage can be paid out at a higher rate than the children who do take ownership. You can also decide if you want to pay the premiums or have your beneficiaries pay them.
It is possible to avoid paying the CGT for any increase in price going forward if you change your permanent residence from your home to your cottage. Now, this tactic is quite complicated, and should only be attempted with a financial advisor by your side. Whether or not you want to switch your official permanent residence depends on a number of factors, including how long you’re planning on owning each, the value of each, and the amount you believe each will increase in value over the coming years. It’s important to keep in mind that simply switching your permanent residence to your cottage will not eliminate the CGT’s requirements. You will still need to pay CGT on the increase in value from the date you bought it until you switched it to your permanent residence. Like we mentioned earlier, this is a very nuanced decision and one that should not be made without consultation with a professional.
You can just keep things simple and sell the family cottage to your kids today. However, no matter how cheap you want to sell it, you will still need to pay the CGT based on fair market value. That means, instead of your grown children dealing with the CGT after you die, you will have to pay it today. There’s a variety of ways you can pay it, including selling the cottage for the amount of CGT you will have to pay. Then, your children can take out a mortgage to pay off the CGT over time.
Hold on to those perfect summers at the family cottage
Each one of these solutions offers both benefits and drawbacks and can be hybridized with others, to a certain extent. Whatever solution you’re leaning towards, the first and most important step is to open up the discussion. Once you know for sure what the wishes of your grown children are, you can decide on a solution that works for everyone, then speak with a trusted financial advisor.
Don’t let assumptions and poor planning cause havoc with your family. Start making a plan today to keep the family cottage a haven for generations to come.
Contact Bayview Financial today to discuss keeping the family cottage in the family.