Estate Planning for the Family Cottage

The “lazy hazy” days of summer are here and many of us will be leaving the city life to enjoy our favorite “home away from home” our family cottage. For many these properties represent the second largest financial investment we will make. There is, however, an important difference between this property and your primary residence! On the last death of you and your spouse there will likely be a significant tax liability.

Tax considerations

Prior to 1982 it wasn’t important to plan around the eventual sale of a second property because each spouse could own a separate property and designate it as his or her principal residence. Beginning in 1982 this was no longer possible as a couple could only designate one property between them as a principal residence. In addition to this, beginning in Feb.1992, the $100,000 capital gains exemption was modified to exclude capital gains on most real property and in Feb 1994 it was completely eliminated. All of this has had the effect of forcing us to develop ways to pass the cottage on in a tax efficient manner.

Who should the property go to?

For some there is a greater concern than the future tax liability. The question of who to leave the property to is paramount. The best solution may not be to leave it equally to all children. The children may not have the same interest in its future use and a cash bequest, from other estate assets, may be more appropriate to those who would not want the property. You may want to have an open discussion with children or grandchildren to determine who has an interest in using the property and paying the costs of future maintenance.

Can Life Insurance be used?

Life insurance can be a very cost-effective method of providing liquid cash to pay any capital gains. Insurance can be purchased on the single owner of the cottage or, as is most often the case, on the joint owners (mom and dad.) The policy would be a “joint last to die” and because two people are insured, the cost will be less than either could buy individually. The proceeds of the insurance are tax free to the beneficiaries. In some cases the beneficiaries of the cottage and the insurance may be able to pay the premiums. The only potential downfall to this solution is that the owner(s) of the cottage must be in good enough health to qualify for the insurance. Because this may not be the case, let’s look at another solution.

Transfer to a Trust

Consideration should be given to transferring a cottage to an ‘inter-vivos’ (living) trust if there is currently a small capital gain (the transfer of the cottage asset into the trust triggers capital gains). However, this would effectively transfer any future capital gains to the beneficiaries.

A ‘discretionary” trust can be useful because, as mentioned earlier, it may not be clear as to which children may even have an interest in the property. The transfer can take place into this trust and the owners will have unlimited use of the property as well as complete control. This would allow time to decide who the beneficiaries will be. At some later date the property can be rolled out of the trust to the beneficiaries, at the value it was rolled into the trust originally. This will have the effect of deferring tax until the property is sold.

If the parents are over 65 an ‘alter ego’ or ‘joint partner’ trust could be used. With these types of newer trusts there is no deemed disposition of property when the cottage is transferred into the trust. (For a description of these trusts see Big Picture article AE & JP Trusts – New Estate Planning Opportunities.)

A Word of Caution

There have been suggestions that the cottage can be transferred into joint names with the eventual beneficiaries. While this may have the effect of passing the property by “rights of survival” at death, it has major drawbacks. If this is done there will be a capital gain at the time of transfer, the property would be in “joint control” with all owners and it would be subject to claim if there were a marriage breakdown or by creditors of any of the owners. This is clearly not a good solution.

Conclusion

The family cottage can be a source of great enjoyment and fond family memories. For many of us it is important to plan for the appropriate transfer and to provide for liquid cash to pay any taxes. By taking a small amount of time today to plan for this event, a great deal of expense and frustration can be avoided in the future. 

Estate Freezes

Estate freezing is an effective method of minimizing the amount of tax you will pay upon your death. This is because the value of the asset will be frozen at the time of the estate freeze, resulting in future growth being taxed in the hands of the beneficiary. Since an estate freeze requires you to give up future income and growth on an asset, estate freezes are usually done when you are in your sixties or are comfortable with the value of your estate. If an estate freeze is done too soon, you run the risk of running out of money.

Estate Freezing, The Easiest Way

The simplest way to do an estate freeze is to gift specific assets to your adult children prior to death. This requires you to calculate how much you need to live on in retirement and then determine if you have assets in excess of that. The excess assets can then be gifted to your adult children and future income and growth of the asset will now be taxed in your adult children’s hand’s. It is important to note that for tax purposes this gifting will be treated as if you sold these assets at fair market value and therefore if the assets have increased in value you will be subject to tax. In addition, you will have also lost control of these assets and therefore your adult children will be able to do whatever they want with these assets, as the assets are legally theirs.

Estate Freezing, Without Losing Control

If you would like to retain control of the assets in your lifetime, a more formal estate freeze will need to be implemented. A formal estate freeze can be used on a variety of assets including, a portfolio of investments, family businesses or real estate holdings. This type of estate freeze involves either setting up a corporation (if the assets are held personally) or a corporate reorganization of shares (if the assets are currently held in a corporate entity).

How does this work?

The best way to explain a formal estate freeze is through an example.
Let us assume:

• Mr. Smith, age 60 has a daughter Sarah, age 42
• Mr. Smith is the sole owner of a small business corporation, XYZ Corp.

XYZ Corp is currently worth $1 million and is expected to increase in value substantially over the next 10 years. Mr. Smith is comfortable with his current net worth and would like any increase in XYZ Corp shares to attribute to Sarah’s. To effectively transfer the future growth of XYZ corp. to Sarah the following steps need to be taken. Mr. Smith exchanges his XYZ Corp. common shares for 1,000 preferred voting shares with a redemption value of $1 million. These shares are retractable meaning that at any time Mr. Smith is able to redeem his shares for cash (Due to a special section in the income tax act, this reorganization of shares does not trigger any tax consequences). Sarah then subscribes for 100 common shares of XYZ Corp at a nominal value ($1/share) As a result of this corporate reorganization, any future growth of XYZ Corp. will belong to Sarah, as she owns the common shares of the company. This is because common shareholders retain an equity interest in the company, which entitles them to future profits. On the other hand, preferred shareholders retain an equity interest in the company, which has been fixed at a dollar amount. Mr. Smith’s interest in XYZ Corp. has been frozen at the current market value of $1 million. Because Mr. Smith’s preferred shares are voting and he has 1,000 shares (vs. Sarah’s 100 shares), he still retains control over XYZ Corp.

Using a Discretionary Trust

If you would like to pass on future growth of an asset to a number of beneficiaries including minor children, a discretionary family trust could be used. Rather than the beneficiaries subscribing directly for the new common shares (as was the case with Sarah in the above example), the family trust would subscribe for the shares. A discretionary trust would provide protection from the children mismanaging the shares and in addition allow the trustees of the family trust to determine which beneficiaries get which assets and the timing of these distributions.

Seeking Professional Help
It is very important that you speak to a professional advisor prior to undertaking an estate freeze. Your lawyer, accountant and The Butler / Laing Group can help you determine what is ultimately appropriate for you.  Contact us at (604) 535-4749, or use our contact page.

Note: The above article is for information purposes only and should not be construed as offering tax advice. Individuals should consult with their personal tax advisors before taking any action based upon the information in this article.

Take Control of Your Estate

For some, estate planning is difficult to think about, let alone engage in. While we understand the vital importance of getting our finances and legal affairs in order for our heirs, few of us make the time. It’s easy to put off — and besides, the term “estate planning” can conjure up notions of greater wealth than we feel we possess.

But all of us will have an estate to pass on, and want our cherished beneficiaries — be they family or a favourite charity — to receive their inheritance according to our own intentions.

Estate planning is a process

Estate planning is more than simply preparing a Will. It begins with reviewing your current situation by listing both assets and liabilities. Assets include such things as your residence, investments and life insurance. Examples of liabilities are your mortgage, taxes due at death and funeral expenses.

You should also review your Will and powers of attorney (a Mandate in Quebec), both of which need to be current and easy to understand for your wishes to be clear and carried out properly. A Will can become outdated over time, so check at least every three years that it conforms to your current situation or, after a major family event such as marriage or birth of a child.

If you don’t have a power of attorney, consider having one prepared. If you become mentally or physically incapacitated, your Will does not apply, and only a pre-arranged power of attorney can guarantee someone you trust will be able to act on your behalf in overseeing your affairs.

The next step is to determine your goals and objectives for your estate. In some cases, tax planning will be a priority. In others, the timing of income to beneficiaries is essential. It’s helpful to walk through the possibilities with expert advice, develop priorities, and identify any gaps between your current situation and your ultimate goals.

Filling the gaps

For many, life insurance is a useful way to fill any gaps. Younger individuals without significant assets can use life insurance to create an estate that will provide their beneficiaries with security. Older individuals who have already accumulated other assets can use life insurance to help preserve the value of their estate. Often, taking the first step to prepare an estate plan is the most difficult. But once you get started, you’ll find it’s not as hard as you expected.

The Butler / Laing Group has the knowledge, resources and teams of experts to guide you through the estate planning process, and give you the comfort of knowing that you have prepared for the future.  Contact us at (604) 535-4749, or use our contact page.