Tax Consequences of Keeping a Family Cottage and How to Mitigate them with Estate Planning

When it comes to the family cottage, it can be one of the trickier aspects of estate planning – both in terms of emotion and financial considerations.

It’s important for families to have open dialogue about the cottage.  Though not always easy, having these conversations allows you to determine if the kids actually want the cottage.  Even when family members express interest taking on the asset, there are other considerations.  Can they afford to keep it?  If they can, is that where they want to direct their time and money?  Does their family live close enough to use it?  What’s their marital situation – does your son or daughter in law have access to a cottage of their own? 

If the interest is split amongst your heirs, for example, one child would like to have the cottage and one is not interested, equalization of inheritance becomes a problem.   The one who receives the cash will have to pay the tax bill on the cottage. 

Tax Implications

Under the Canadian tax system, you are deemed to have sold everything you own immediately prior to death.  The estate is calculated at fair market value – including real estate. 

If the cottage has increased in value over the time you have owned it, it could result in a significant tax bill. 

One exception to this is referred to as the spousal rollover.  Essentially if assets are left to a surviving spouse, they are transferred at cost and there is no deemed disposition until the spouse dies.  For this reason, this planning contemplates how to plan for the tax consequences of the last to die.

Two primary tools for handling the cottage in your estate are principal residence exemption and a proactive sale of the property.

Principal Residence   

The gain on increase in value of real estate can be sheltered from tax by using the principal residence exemption.   This exemption can only be used on one property in any given year. If you own both a home and a cottage, you will need to determine which property has the higher gain and therefore should be covered by the principal residence exemption.

Gifting or Selling

Gifting or selling the cottage to your heirs for less than fair market value does not avoid tax and can actually make the tax consequences worse.  This is never an advisable option!  Even if you sell for less than fair market value, you are deemed to be selling at fair market value and need to declare and pay tax on the gain in value.  Meanwhile your heirs receive the property at their acquisition cost and they will have to pay tax on the same gain that you paid tax on when they eventually sell the property.  This creates a situation of double taxation.

One option of proactive planning is to sell the cottage property to your children while you are still alive.  If you have agreed on who should get the cottage property, you can sell the property in advance.  The capital gain would be declared in the year of sale, which in many cases can be in a year where your marginal tax rate is lower than it would be in the year of death because you won’t have the deemed disposition on all your other assets. 

You can spread the tax consequence on the gain over 5 years by using the capital gains reserve.  It also means you won’t be subject to tax on any gain in value that occurs between the time of sale and the time of death.  If real estate values keep going up, that could be significant.

A transfer of ownership while still alive can alleviate a lot of headaches down the road and provide a some tax savings.  There are a few reasons to consider this option carefully, such as potential matrimonial or creditor issues.

Proactive Planning Options

Proactive planning options  you could take to plan for succession but also maintain control of the asset until death:


  1. Inter-Vivos or Family Trust
    This is a trust that you establish while you are alive, and it is generally the most popular one.  The cottage is transferred to the trust during your lifetime.  A deemed disposition occurs at the time of the transfer thereby resulting in capital gains, but the cottage no longer forms part of your estate on death.
  2. Testamentary trust
    In your Will, you can create a testamentary trust to hold the cottage for the benefit of your heirs subsequent to your death.  You are still deemed to have sold the cottage property for fair market value at the time of death, so there are limited tax benefits to this.  Many times there are non-tax reasons for doing this, including protecting the property from claims in the event of a marriage breakdown or bankruptcy of the heirs.

It’s important to take steps to minimize exposure to these risks, and a testamentary trust is an excellent example.  Within the trust, you can stipulate and fund a maintenance account for to cottage to pay the related operating expenses, which can help ensure that all your heirs, no matter of affluence, can enjoy the cottage after you’re gone.  There would still be a deemed disposition and tax bill owing, not to mentioned funding the maintenance account. 

Last-to-die Life Insurance Policy

One popular strategy to ensure your estate is sufficiently funded is a joint last to die life insurance policy, where the death benefit pays the tax on the cottage and funds the maintenance account.  Life insurance can also be a vital tool in equalizing an estate if you have multiple heirs. 

Know Your “Whys” and Plan

Remember, the reason you’re keeping the cottage in the family is so that it is a source of joy for the family, not a source of conflict.  When multiple parties have a stake in an asset, no matter the ownership format, it’s critical to establish governance, and a share-ownership agreement can be used to accomplish this.  At a minimum, you want to outline:

  • How decisions will be made.  What happens when owners want “out”.  How will the property be managed and kept?
  • A usage schedule that differentiates between shared and exclusive usage, and if the property can be made available to rent to a third party
  • An estimate for maintenance and a mechanism for determining how these costs will be paid
  • A plan for capital improvements.  How long will the septic tank last, the dock, the roof?  How will these larger expenses be split amongst the owners.

Getting this down and on paper will allow for something to which you can reference back and help minimize conflict scenarios.
As is the case with many estate planning topics, there is no one-size fits all strategy.  It is very dependent on your objectives and the family dynamic.  But proactive planning can go a long way to reducing tax and ensuring a smooth transition.

Importantly, you’re not alone. 

The team of trusted advisors at Welch LLP are here to help outline your options so you can make informed decisions for both your household, and those future generations. Learn more about our Family Wealth Advisory Group.

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