Creating a succession plan

Lawyer Peter Lillico's six-point plan

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Step 3: funding the capital gains tax liability

Suggestions from Lillico include severing and selling off a lot that will help pay the tax, or even asking the children to help fund the premium on a life insurance policy that would pay out a sum at death roughly equal to the estimated tax bill. One other possibility is asking the children to start saving now to pay the tax man or prepare them for the possibility of taking out a loan later.

Step 4: deciding when and how to give the cottage to the children

This is the hard part, but basically it boils down to giving it or selling it to a child or children, or transferring it into a trust, a non-profit organization, or a corporation—all of which are considered to be dispositions at fair market value. So even if you gift the cottage to your children, for tax purposes, it is considered to have been sold at full value and you’ll be taxed on that basis.

Step 5: preparing a co-ownership agreement

Several of the lawyers I talked to advised against choosing a corporation. Although a corporation can work like a classic estate freeze and allow taxation to skip a generation, accountants advise that any family member spending time at the cottage would need to calculate the fair market value rent for those days, and include that in their income as a taxable benefit from the corporation that owns the cottage (deducting against that any payments they made toward operating costs). Setting it up and completing the corporate filings and tax returns can be complicated and disadvantageous. “We tell our clients it’s not a good idea,” say accountant Beth Webel and succession-planning specialist Luanna McGowan at PricewaterhouseCoopers in Hamilton, unless the clients are buying a vacation property in the U.S. where it enables them to avoid paying U.S. estate tax. A trust can be beneficial if you are concerned about a child’s financial insecurity or immaturity. And some families find it works for a larger property or cottage compound. One thing that is important, no matter which option you choose: At the time of transfer to the children, your lawyer should provide you with documentation recording the transaction as a gift, so that a divorcing spouse can’t force a sale under the Family Law Act.

At the very least, advises Karon Bales, an estate-planning lawyer with Gowling Lafleur Henderson in Toronto, set up a co-ownership agreement for the children and include a shotgun clause. That gives siblings who do want to extricate themselves an out. Under this kind of buy-sell clause, a sibling can name a price for the others to buy him out. If the other siblings turn him down, he has the option of buying each of their shares for the same price. It may not be a good solution, however, in situations where the siblings do not have similar financial resources. As Peter Lillico says, this seemingly fair mechanism could result in one sibling losing the cottage to a more affluent one at less than fair market value.

Other hostility-reducing clauses in a co-ownership agreement might include: a system whereby the owners exchange preferred dates by, say, April 1 and take turns getting first choice of the best weeks or cottages; a provision to allow the owners to renegotiate terms as their life circumstances change; and language requiring majority consent for major expenditures. Karon Bales has a rule in her family that would be a helpful clause in any co-ownership agreement: Whoever closes the cottage in the fall, also opens it the following spring. “Then if you screw up in the fall, it’s not someone else’s problem when they open in the spring,” explains Bales.

Step 6: creating a testamentary trust to help fund cottage operational costs

A testamentary trust is one that is created with funds set aside in the parents’ wills for a specific purpose. For cottaging families, a testamentary trust designed solely for cottage use is a great vehicle for helping to cover fixed costs such as cottage property taxes, insurance and utilities, and/or major repair projects and improvements such as a new dock or roof. Lillico suggests that the investment income can be used to help reduce the annual carrying costs that each child would otherwise pay. Or, he notes, trust capital can be used to fund major projects such as a new septic system if one or more of the siblings is unable to share the cost, although that approach would gradually whittle down the capital in the trust.

Tax lawyer Arthur Drache, with the Ottawa law firm of Drache, Burke-Robertson & Buchmayer, says the cottage is usually the most sticky point in any estate planning. “In most families nobody thinks twice about the family home. The parents die—you sell the house, even if you grew up in it. The cottage, on the other hand, generates emotion and possessiveness that is far out of keeping with anything else.”

This article was originally published on May 17, 2004

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