07 May, 2021 Financial Planning Wealth Management

What’s Next for the Family Cottage?

Muskoka chairs on dock.

For many Canadian families who own a cottage — many of our clients included — knowing what to do with your vacation property, and how best to keep it in the family in the future is a challenging task.


There are three major issues that can prevent passing down the cottage. Here’s an overview of each issue. In our next post, we cover succession strategies to deal with each one of these issues.

Issue #1: The Federal Capital Gains Tax (CGT) Liability

As the value of waterfront property skyrockets, today’s Canadians have to pay higher Federal Capital Gains Tax (CGT) than any generation handing down property before them. The CGT is the primary reason that cottages are sold out of families — when the kids inherit the beloved cottage, sometimes their only option is to sell the cottage in order to pay the tax.


This tax is calculated by determining the difference between the current value of your property and the adjusted cost base (the value of the property when purchased plus any renovations). As CGT only came into law in 1971, Canadians are only taxed on gains made since then. CGT is inevitable, so knowing how you or your estate will pay the tax bill matters for your bottom line. 


If you choose to give the cottage to your children, for example, 50% of that difference will be added to your income and you (or your estate) will pay marginal taxes based on that increased income. This will influence your tax bracket and whether you qualify for Old Age Security for that year.  


You could also sell the property to your children over an extended period of time. By doing this, you would only pay CGT on the portion sold, thereby considerably reducing the amount of taxes to be paid.


Whatever you do, do not sell the cottage to your children at a lesser value than the market price as it will result in more taxes down the road. A workaround to this is to sell the cottage to your children at full value on paper, accept the discounted amount in cash and have the remaining paid out in a promissory note which you can forgive. You will need an attorney’s help with this and you may pay a little more on land transfer taxes, but it will be much cheaper than paying more CGT.

Issue #2: Estate Administration Taxes (Probate Taxes) 

Every province (except Quebec) charges probate taxes on assets that pass through the estate. If the property (asset) is held as Tenants in Common or under Single Ownership when that primary owner passes away the surviving partner will pay taxes on the cottage. Taxes will then be charged again when they also die. To avoid this, it is a good idea to hold the cottage as Joint Tenants. This way, probate taxes are only triggered when both partners have passed on. 


It’s important to note, Tenants in Common may be useful in certain circumstances, but it’s best to discuss that with your accountant and/or lawyer to see if it’s right for you. 


Another way to avoid probate is to place the property in a trust, where it is not considered part of the estate assets and therefore is not subject to probate. More on that below.

Issue #3: The Principal Residence Exemption 

Principal residences are exempt from Capital Gains Tax. In Canada, a married or common-law couple can only list one principal residence. Your principal residence does not have to be where you live full time and whether you rent it out on a short-term basis does not impact the status of the home. 


If you own multiple properties, deciding what to list as a principal residence should be based on the annual average gain of each property, any potential gain or loss for each property, and current and eventual liabilities. In some cases, it makes sense to list your cottage as a principal residence.


Principal residences typically cover the cottage and a half-hectare of land, unless you can prove that additional land has contributed to the use and enjoyment of the land.

How can you deal with these issues?

While these may be issues, there are some strategies you can use to pass your cottage on to the next generation while mitigating the above issues.


As always, our recommendation is to seek advice from experts in each of these areas — whether your advisor, an accountant or an attorney. Good advice can protect you and your family from unexpected costs.


For an in-depth look at strategies, see our post on family cottage succession strategies.