Whether it be a lakeside summer home, a small log cabin in the woods, a ski chalet, or a country retreat, a family cottage can be the source of wonderful memories and an important part of family life. However, it can also become a source of stress and disagreement if not dealt with properly in the estate-planning process.

Planning for the family cottage can be challenging, in part because clients often have competing emotion-driven objectives. The desire to treat all children equally and to ensure long-term family ownership, while admirable, may increase and accelerate tax payments. This in turn can cause conflict within the family and paradoxically may make continued family ownership less likely. Passing on the family cottage is also challenging because of the inherent uncertainty associated with planning for the future. Changing financial circumstances, ever-varying aptitudes and expectations among family members, the arrival and departure of unpopular spouses, and the realization that the family cottage is “not quite the same” after the death of the parents are all factors that can shatter the best laid plans.

Fortunately, many options exist to deal with the family cottage, and numerous articles have been written on the topic. This blog does not attempt to canvass all possibilities; rather, it briefly highlights two planning options that are available to address a client’s objectives:

1. transferring the cottage to a non-share capital corporation, and
2. including a “shared cottage test run” clause in a will.

Transferring the Cottage to a Non-Share Capital Corporation

Although less common, the option of using a non- share capital corporation may be advantageous when parents want to keep the cottage in the family for generations to come. Neither the 21-year deemed disposition rule nor the rule against perpetuities applies to corporately held property. However, this option is expensive and may be suitable only in the context of a family compound that has the capacity to benefit future generations and a family that has sufficient resources to fund the ongoing expenses associated with the property.

The transfer of the cottage property to the corporation gives rise to a disposition for tax purposes, and therefore any accrued capital gain must be accounted for by the transferor at the date of transfer. No rollover is available on the transfer of property to a non-share capital corporation because the requirement in section 85 that the transferor receive share consideration on the transfer cannot be met. As in the case of a transfer to a trust, the principal residence exemption may be available to reduce the amount of tax payable. Land transfer tax may also be assessed.

The rules regarding admission to the membership of the non- share capital corporation should be included in the articles or bylaws of the cottage corporation. As in the case of a shareholders’ agreement in a regular corporation, appropriate safeguards must be considered, negotiated, and put in place to eliminate any potential conflicts between members that could ultimately defeat the plan to keep the cottage property in the cottage corporation indefinitely for the benefit of succeeding generations. Similarly, safeguards are needed to ensure that the members, or a subset of the members, cannot collude to wind up the cottage corporation for their personal benefit and thereby sacrifice the enjoyment of the property by other family members or future family members.

The manner in which the expenses of the cottage corporation are funded must also be determined. Often, these expenses are provided for by the payment of annual dues by the members of the corporation. If the members have different economic means, consideration could be given to creating different classes of membership fees. The cottage corporation should also have the power to levy special fees to deal with the unexpected expenditures that will inevitably arise.

In the absence of a specific provision in the articles or bylaws, the interest of a member in the cottage corporation is not transferable; rather, it lapses on his or her death or when he or she ceases to be a member. As a result, no probate tax or capital gains tax liability arises on the death of a member. Despite this advantage, however, members may incur an ongoing tax liability under the shareholder benefit rules if they use the cottage without paying the cottage corporation for its use. If the article or bylaws allow for transfers, additional measures should be put in place to prevent unsuitable persons from acquiring the interest.

Provided that certain conditions are met in each year of its existence, the cottage corporation can also qualify as a non-profit organization for the purposes of the Income Tax Act, and thus be exempt from tax. However, some of the conditions can prove to be restrictive in the wake of changing future circumstances, and therefore seeking non-profit status may be desirable only if it is anticipated that the cottage corporation will earn taxable income.

Using a non-share capital corporation to transfer the family cottage can be complex and costly. Professional advice is required to set up the corporation, draft the bylaws, and create member agreements. There are also ongoing administration costs. If the corporation also qualifies as a non-profit organization, an annual return must be filed. A cottage corporation is suitable for families that have considerable resources, wish to keep the cottage in the family for generations, and work well together.

Including a “Shared Cottage Test Run” Clause in a Will

This type of clause often provides that the property is to be held by the executors and trustees of the parents’ estate for a specified time, perhaps a year or two, with all cottage-related expenses paid by the estate. During this period, children have the opportunity to experience shared ownership of the cottage. At the end of the period, ownership of the cottage is divided equally among those children who wish to acquire an ownership interest. If any children do not wish to acquire such an interest, their interest must be purchased by the other children. If none of the children wishes to acquire the cottage, or if the children cannot agree on how ownership is to be shared, the cottage is sold.

The clause should specify how the value of the cottage is to be determined for the purpose of valuing the ownership interest of the children who choose not to inherit the cottage, how disputes about the purchase process are to be resolved, and what process is to be followed if a child predeceases the parents and leaves surviving grandchildren.

This strategy may attract land transfer tax that would not be payable if the cottage property were conveyed to a single child. Depending on how the clause is drafted, partial land transfer tax relief may be available. In addition, this approach also potentially delays the determination of who will inherit the cottage by passing responsibility for making that decision to the children.

Conclusion

Although cottage life may be idyllic and associated with the simpler things in life, cottage planning can be anything but simple. Fortunately, families have many options available to assist in achieving their objectives, each with their own advantages and disadvantages. However, diligent planning increases the chances that a family cottage will continue to be enjoyed by future generations and that existing family members will continue to remain friends and not become foes.