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The Family Cottage: How to Plan What Happens Next

The Family Cottage: How to Plan What Happens Next

For many families, a summer cottage has been their getaway home. It’s their break from the hustle and bustle of their lives and a breather from the mundane that life tends to be. It also becomes the place where families unite for vacations or breaks and therefore, holds immense emotional value.

The estate trustee must follow the terms of the will, or if no will, the laws of intestacy and have the legal and fiduciary duty to act in the best interest of the estate and maximize its value. Trustees must follow the terms of the trust. Family members usually have different ideas on how to utilize the property upon the owner’s death. Sometimes the cottage must sell.

When planning for their estate, owners of the cottage may wish to consider some of the following estate planning options.

Cottage trust

 Cottage owners may wish to consider setting up a cottage trust in their will or by an inter vivas trust (a trust set up while they are living).

The cottage trust set up in their will may state that the cottage will be held for the benefit of their children and grandchildren and cannot be sold for a certain period. The will may stipulate that at the end of the period of time, any of the remaining beneficiaries would be able to purchase the cottage with the remaining beneficiaries receiving the sale proceeds (ie. a buy-back mechanism).

If set up via an inter vivas trust, the trust instrument can appoint a trustee and transfer the cottage to the trustees. The trustees would hold the cottage in trust pursuant to the terms of the trust.

This is one way of avoiding conflicts amongst the parties as it allows the children to use the cottage for a certain period of time. However, trusts must be managed by a trustee (and their fees for managing the trust) and don’t forget the rule in Saunders v. Vautier [1841] C.C.S. NO. 14 which says that if all the beneficiaries of a trust are of the age of majority and sound mind (ie. sui juris) the trust may be terminated if all the beneficiaries wish for this to happen. We note that this rule stemming from the English case has become more complicated. Overall, the testator must use caution when considering setting up a cottage trust as it may have unintended consequences.

Right of first refusal

This clause can be used in a will or trust instrument to give an individual the option to purchase specific property from an estate or trust. It is most common for real estate, such as a cottage. This provides the testator with an opportunity to set up a mechanism for handling the distribution of the cottage by giving one child the first right of first refusal to buy the cottage.

Capital gains tax

It is likely that the cottage will not be considered the principal residence of the deceased. A cottage is considered a capital asset when it comes to taxation. Therefore, during the estate planning, the owner ought to consider the implications and applicability of the capital gains tax upon the transfer of the cottage to the proposed titleholder. If the cottage is held in joint tenancy, it passes through right of survivorship to the surviving spouse and there are no tax implications. However, on the death of the surviving spouse, the cottage must be first transferred to the estate. The estate trustee administers the cottage pursuant to the terms of the will, or if no will, the laws of intestacy.

Disposition of the cottage (transferring title from the estate to someone else), if it is not the deceased’s principal residence, would trigger capital gains tax. Half of the cottage capital gain would be taxable on the increase in value from when it was purchased to when it is sold to someone else.

Probate fee and property tax

 Like the capital gains tax, a probate fee (and some other property taxes) may be applicable. Real estate in Ontario is an asset subject to probate tax (which is 1.5 per cent of value of estate over $50,000). To avoid probate tax, families may wish to add their adult child as a joint tenant, but you must be cautious when doing this as there is a risk of the child taking the position that they own the cottage outright as it is an asset that passes outside the estate. However, there is a presumption that the child is holding it on a resulting trust for the benefit of the estate (see Pecore v. Pecore, 2007 sec 17. Also, see our articles: What is estate administration tax, parts one, and two for more information on probate tax, particularly part two which discusses joint ownership).

The cottage is a meaningful asset that forms part of the estate and there are many considerations for the testator who is planning their estate as well as to the beneficiaries inheriting the cottage. A recent issue of Maclean’s dubbed Ontario’s Muskoka region as “The Olde Faithful,” estimating the average recreational property price in 2022 to be $842,000! Careful consideration must be made when dealing with the cottage.

The Pro’s and Con’s of Joint Ownership: Part 2 of the Estate Administration Tax Series

In case you missed our last article, we covered the essentials of the estate administration tax (estate tax): who applies for it, how is it calculated and who pays for it. Now that we have covered the fundamentals, we can discuss strategic tax planning. When tax planning for estates is done correctly, estate tax can be reduced or avoided.

In this six-part series, we will be discussing five different methods to consider in order to reduce or avoid the estate tax. These are: joint ownership for property, naming a beneficiary for your assets, gifting assets, holding assets in trusts and making primary and secondary wills.

In this article, we will be explaining how to reduce or avoid estate taxes through joint ownership of property. To understand how to do this correctly, we will first need to explain the basics: what it means to be a joint owner vs. tenant-in-common, the right of survivorship and how property can evade the probate process through this designation.

Joint ownership and right of survivorship

Joint tenancy allows for two or more people to own property together, equally and indivisibly. It is the most common form of homeownership for legally married spouses in Ontario.

Pros

There are many benefits to jointly owned property, for example, if one owner loses mental capacity, the other owner(s) may proceed to make decisions about the property.

Another benefit is when one owner dies, their interest in the property automatically transfers to the surviving owner. This is called the right of survivorship. This means that the deceased’s will does not determine how the ownership in the property will be dealt with. It is the surviving owner who owns the whole property.

No probate tax

 As mentioned above, assets held by the testator and another joint owner with a right of survivorship do not form part of the estate. Because jointly held property passes on right of survivorship, it passes to the surviving owner outside the deceased’s estate. If there is only one name on title, the property must be included in the probate process along with all other assets of the estate. This would significantly increase the amount of estate tax that must be paid before the assets of the estate can be distributed to beneficiaries.

There are two exceptions to this general rule:

  1. When two joint owners die at the same time, or in situations where it is unclear who predeceased the other, they are deemed to have held the property as tenants-in-common.
  2. If the property is designated as a matrimonial home for the child, 26(1) of the Family Law Act (FLA) states that the joint tenancy will sever if the child predeceases the parent.

The Supreme Court of Canada decision in Pecore v. Pecore, 2007 SCC 17 held that there is a rebuttable presumption of a resulting trust in the case of a transfer between a parent and adult child. In this case, a father added his daughter as a joint tenant to his financial accounts before his death. In the father’s will, the estate was to be split between the daughter and her husband. When the daughter and the husband divorced, the courts considered whether the financial accounts were to fall back to the father’s estate or pass to his daughter outside the estate by joint tenancy (of the bank account), through the right of survivorship. The Supreme Court determined that the father intended to gift ownership of the account to the daughter. If the father’s intent had been missing, there would be presumption of a resulting trust. The onus would be on the adult child to rebut the presumption. Make sure to distinguish between transfers to a minor child, where a rebuttable presumption of advancement would apply.

Cons

 If you decide to pursue a joint ownership to avoid/reduce the estate tax, be careful — there are possible adverse consequences for joint ownership. The following risks typically arise with parent to child joint ownership transfers with right of survivorship:

  1. Real estate: remember that the testator will lose exclusive control over the property. The consent of the child will be required to sell, encumber or transfer the interest of the Be mindful of who you are adding as a joint owner — all owners are registered on title. The actions and debts of one owner may compromise title that will inevitably impact the other joint owner(s) as well.
  2. Bankruptcy/creditors: Creditors of the child, if any, may have an interest in the property should the child have financial
  3. Family Law Act: As mentioned above, if the property is designated as the matrimonial home for the child under Part II of the FLA, the joint tenancy will sever if the child predeceases the
  4. Income Tax Act: Adding a new joint owner may trigger adverse or unexpected tax consequences where beneficial ownership is transferred. For example, if the transferred property is the parent’s principal residence (and not the principal residence of the child) the transfer will likely result in a loss of a portion of the principal residence exemption for future taxation You should determine whether the potential savings (1.5 per cent) are worth the risks.

Tenants-in-common

Tenants-in-common is a type of joint ownership where two or more individuals own a divided interest or share of the property where no rights of survivorship exist. This type of legal relationship is beneficial for individuals who may wish to leave their respective share of property to specific beneficiaries, for example, business partners who would like to leave their share to their families, or those involved in a second marriage who would like to distribute their share to children in a previous marriage. If one owner dies, their share of the property passes on to their estate and will be distributed in accordance with their will or the laws of intestacy. The surviving owner retains their percentage interest in the property.

A tenancy-in-common will generally be subject to a probate process and associated estate taxes because the deceased’s interest in the property forms part of the estate upon death. As part of the estate, the value of the interest must be ascertained in the probate process and estate tax must be paid upon the total value of the estate.

Plan wisely

Thinking ahead about how to designate your property between joint-ownership and a tenancy-in-common will help you strategically avoid or reduce taxes in estate planning. Next up in our series, we will discuss strategies in naming beneficiaries for assets to pass outside the estate to reduce or avoid estate taxes.

This is the second of a six-part series. Read the first article: What is estate administration tax, part one.