An innovative way to solve your family cottage dilemma
Originally published in Financial Independence Hub, May 30, 2019
Sipping your morning coffee on the dock with your spouse; teaching your children to waterski; and roasting marshmallows with your grandchildren. These are just some of the treasured memories you’ve created at your family cottage. But times change and those memories can sometimes be replaced with concerns about how to deal with your family cottage dilemma:
You enjoy spending time at the family cottage, but the time, cost and stress associated with it are turning a pleasant summer pastime into an ongoing headache.
To illustrate this dilemma, let’s consider Doug and Barb’s situation. Barb inherited their cottage from her mother just after they got married. They now have three adult children and six grandchildren, and are recently retired. While they’re looking forward to spending more time at the family cottage, they see a number of issues on the horizon:
- Two of Doug and Barb’s adult children are professionals, while the third owns her own growing company. These time demands mean none of the children are able to visit the family cottage as often as they’d like.
- There are several steep sections of stairs between the family cottage and the dock on the lake below. While Doug and Barb can navigate these stairs now, they’re concerned they won’t be able to as they get older.
- Doug and Barb do not know who they will leave the family cottage to.
The most pressing issue for Doug and Barb is the time commitment for maintaining the cottage. They’re the only family members with the time to open and close the property, and maintain it throughout the summer months. While they’re both healthy enough to do this now, they’re concerned that they may no longer be able to as they grow older and their physical health declines.
There’s also the issue of costs related to maintaining the cottage. The cost of repairs and improvements to host their growing family and their friends means the simple family cottage they inherited from Barb’s mother a generation ago has morphed into a monster home on a lake!
Additionally, there’s the question of how these capital improvements and the maintenance costs will be shared amongst family members. Should Doug and Barb continue to pay for the upkeep? Or should that be split amongst the adult members of the family? How would they split these costs – evenly, or based on actual cottage usage?
Finally, there are the succession and estate planning issues to consider. Which of the adult children will get the cottage? Do any of them really want it? What about the personal taxes triggered when the cottage is transferred, or the probate fees (Estate Administration Tax in Ontario) if they both should pass away unexpectedly?
As you can see, Doug and Barb have a number of issues to contend with. They continue to enjoy the family cottage experience, but need a solution to address these issues.
Consider establishing a Family Vacation Trust
One solution for Doug and Barb to consider is establishing a Family Vacation Trust to pay for their family’s future summer vacations. A Family Vacation Trust would allow their family to continue to enjoy the annual cottage experience without the responsibility and costs of maintaining one.
Here’s an example of how their Family Vacation Trust might work:
- Let’s assume the value of the cottage when Barb took possession was $100,000 and it’s currently worth $800,000. Selling expenses will be 5% of the sale price and the resulting capital gain will be taxed at the highest personal marginal tax rate in Ontario*. This situation would result in Doug and Barb receiving approximately $580,000 on the sale of their cottage.
- The net proceeds from the sale would then be transferred to the Family Vacation Trust. Doug, Barb and their three children would be listed as beneficiaries in order to take advantage of income splitting opportunities. Due to the tax situations of each family member, and the top marginal tax rate of the trust, the family should review the allocation of the trust’s income each year with a tax professional.
- Their Family Vacation Trust would then invest the net proceeds in an investment portfolio to generate the income used to fund the family’s annual vacations. If this portfolio generated an annual after-tax return of approximately 3%, this would mean it could earn approximately $17,000 per year.
- Doug and Barb’s family could also expect to save the annual costs of owning the family cottage (repairs, property taxes, etc.) and the future costs of personal property used at the cottage (jet skis, fishing boats, etc.). If we assume these costs are approximately $13,000 per year, when they’re added to the income generated from the Family Vacation Trust, Doug and Barb’s family would have approximately $30,000 to spend on renting a cottage. The cost of renting a cottage will vary across Canada and will depend on its location, time of year, size and amenities.
- Doug and Barb may also want to consider other family vacation opportunities such as renting a chalet in British Columbia, a villa in the Caribbean or a small farm in the south of France.
- Before proceeding with the Family Vacation Trust, Doug and Barb will have to consider the legal and accounting fees to set up and maintain this planning vehicle, and the time to oversee its annual administration.
The benefits of starting your own Family Vacation Trust include:
- You can choose a new cottage each year to spend your family vacation.
- You free yourself of the time and costs associated with maintaining the family cottage, and can spend that time enjoying your family instead.
- Placing the net proceeds from the sale of your cottage in a Family Vacation Trust, and designating the use of the trust’s capital and income for family vacations, ensures the money won’t be spent on any unintended uses
As for succession and estate planning issues:
- If one of the co-owning family members passes away, this will trigger probate fees. With a Family Vacation Trust, these fees can be avoided.
- The Income Tax Act assumes that the investment assets held by a Family Vacation Trust are sold every 21 years, which triggers capital gains tax. However, if the capital gains generated by the investment portfolio are harvested each year and allocated to family members on a tax-efficient basis, this deemed sale would result in only nominal income taxes.
- Your family could benefit from credit and divorce protection since the investment portfolio is legally owned by your Family Vacation Trust, not by individual family members.
Some families will have a strong emotional attachment to their cottage, especially if it’s been in the family for generations, so this strategy may not be right for them. But for those who want to maintain the family cottage experience without the associated headaches, consider speaking with your financial advisor to learn about establishing your own Family Vacation Trust.
Jason Kinnear is the Family Office Services Manager at T.E. Wealth, a trademark and business name of iA Investment Counsel Inc. Jason specializes in assisting entrepreneurs and their M&A advisors with pre and post-sale succession planning. He is a Chartered Professional Accountant (CPA), Chartered Business Valuator (CBV) and a graduate of CPA Canada’s In-Depth Tax Course.
* You may also be able to make a portion or all of this transaction tax free if you’re able to use your principal residence exemption. Consult your tax professional for details.