What is cottage succession?
Succession of your family vacation property, whether you call it a cottage, camp or cabin, is its transfer to new ownership. You can leave it to your heirs, sell it to your adult children, give it to them as a gift, transfer it to a trust (especially appropriate if further generations are expected to use the property), transfer it to a non-profit corporation created specifically to own it, or sell it to an outside party. The property can even be donated to charity.
Cottage succession is something your family must discuss and plan, not something that happens automatically when the original owners pass away. Simply adding to your will “I leave my cottage to my son and my house to my daughter” will not prevent discord, and in fact may increase it because the tax consequences of inheriting the two properties might be significantly different, even if their value is the same.
Planning for the ownership change
Before you get into the financial details, your family needs to talk openly about the future of your vacation property and answer important questions such as who among the children or grandchildren wants to keep the cottage. Which family members can afford the upkeep? Do adult children and their respective families have the time – and do they live close enough – to regularly use the property and to do the work to maintain it? Think particularly about the work involved in opening and closing the cottage at the beginning and end of each season if it’s not in year-round use.
Examine each family member’s usage pattern over the past few years. Dividing ownership equally doesn’t make sense if they don’t use it equally and/or can’t equally afford their fair share of the ongoing costs.
An underused cottage is an invitation to vandals, decay and loss of value, and if it falls into disrepair, it will be used even less. Fond childhood memories alone are not a good enough reason to keep a property the family can no longer use to full advantage. But if your family does want to keep it…
Multiple owners can mean multiple problems
You may be considering joint ownership by your adult children. This will work only if they use it equally. If you do decide on joint ownership, draw up a formal agreement with the assistance of a lawyer. Be sure to include a buyout provision in case one owner wants to sell to the others. Also include details on how expenses will be covered, how usage time will be “reserved,” what happens in cases of marital breakdown, and how decisions – large and small – will be made.
An alternative is to create a non-profit corporation to own the property and have family members pay “membership fees” to use it. Future generations could continue to pay their fees to use the property, and taxes would be deferred until it is eventually sold. Before attempting this strategy, seek professional tax advice. As with joint ownership, a formal agreement will be needed.
Be prepared for some acrimony in these discussions; consider having these conversations facilitated or mediated by a professional advisor. You and your extended family may get along beautifully when you’re all at the cottage now, but you can’t be sure that will continue when the children become the owners. Disputes over cottages have torn families apart.
Tax consequences of ownership transfer
It may be possible to claim the Principal Residence Exemption on the vacation property provided that it is not used to earn income and that it is ordinarily inhabited at least seasonally hughesairco.com. If you can claim this exemption, you may be able to shelter capital gains on the sale of the property. Otherwise, a tax liability on the appreciation in the cottage’s value will likely arise on disposition, whether you sell it or give it as a gift, or whether it is deemed disposed of on your death if your spouse has already passed away.
At the time of disposition, the fair market value of the property will be determined, as will its adjusted cost base – which includes any improvements made over the years. The difference between the adjusted cost base and fair market value is a capital gain and will be taxed as such to your estate. Have a plan for funding capital gains tax if it is triggered. One way is to specify that a portion of your life insurance proceeds will cover it.
Where family memories, perceived fairness, money and property intersect, strife and problems often lurk. So arrange a family meeting and talk with your tax advisor and your lawyer about the transfer of your vacation property – before it becomes an urgent problem.