3 succession case studies
How these cottagers passed on their properties
Situation: Large property, large, tightly knit clan
Solution: Non-profit organization
Quite popular in the 1950s and ’60s, the non-profit organization enables successive generations of family members to use the cottage or cottage compound without incurring capital gains tax or provincial estate administration (probate) fees. Of course, capital gains tax will apply up front when the family transfers the property into the non-profit, but after that, the cottage can roll along for decades without triggering more. That’s because once the property is transferred, family members are no longer owners, but dues-paying members of a cottage that operates like a club. The member-elected board of directors can decide who qualifies for membership, be it blood descendants of the matriarch and patriarch or those chosen by other criteria. Membership is not passed from parent to child, so there is no inherited asset that can be taxed. Children become independently eligible for membership at an age set out in the bylaws (perhaps at 21 or 30) and their membership expires at their death. Spouses may qualify too. Only if the board of directors, who can be family members, decided to sell the property and wind up the organization, would tax on capital gains apply once again.
If you’re wondering why a cottage property would qualify for non-profit status, remember that non-profits are not charities. In fact, a charitable organization is not eligible. The main criterion is that it should not make a profit. As a Canada Customs and Revenue Agency bulletin published last August sets out, non-profits must be organized “exclusively for social welfare, civic improvement, pleasure, recreation or any other purpose except profit,” and not distribute any income to individual members.
Although it can be scary to think about surrendering control of this beloved heirloom, a non-profit can be an ideal solution for people whose property is large and has extraordinary physical features: perhaps a 1920s Lake of the Woods fishing camp; a cottage compound on a long private sand beach; a piece of pristine waterfront with old-growth white pines; or a tiny historic cabin. Extraordinary enough that even if the family population explodes, individuals will be content to share.
For example, about 200 descendants of the late Annis Richardson return every year to three breathtaking pink granite islands in Georgian Bay near Pointe au Baril, which are held by a Canadian non-profit organization that Richardson established in 1949 before her death. With three cottages and six sleeping cabins, there are enough beds and refrigerators to accommodate as many as 30 cottagers at a time, which means that most members can book at least a week at the cottage each summer. The annual membership assessment is less than $200 U.S. and pays for fixed expenses such as taxes, insurance, and utilities. Each person, other than those under the age of six, also pays a minuscule per diem for each vacation day at the cottage—a sum that generally helps to pay the cost of cottage maintenance. Non-payment of the membership fee means that cottagers lose the right to book time that year.
Farther east, in the Kawartha Highlands, a majestic three-acre peninsula of Canadian Shield with 1,500 ft. of waterfront and towering white pines has been operated as a cottage non-profit since the 1960s. The Toronto-based matriarch and patriarch who established it bought the vacant land from the Crown in 1946 for $100 and built a 400 sq. ft. log cabin. During the 1960s, when it was apparent that their children and grandchildren were deeply attached to the sandy cove and the rocky swimming point at the tip of the peninsula, the family, who asked not to be identified, transferred the entire property into a non-profit. Today, roughly 35 adult members and a brood of children share the rustic original cabin and three sleeping cabins.
Unlike the Pointe au Baril non-profit, this family made the decision early on to have a two-tier membership system for heavy users versus day trippers. So-called primary users would be those family members who regularly cottage there and manage the property. Their annual membership dues currently stand at $350. Other members —typically those who opted to buy their own cottages nearby, whose spouses were less interested in cottaging with the in-laws, or who eschewed the rustic facilities (no running water, no hot water, just an outhouse) —pay dues of only $20 a year. They have rights to visit during the day for a swim off the point to allow the kids to play on the sandy beach. Far-flung relatives, such as some cousins in Atlantic Canada who have less opportunity to get to the cottage, also qualify for the $20 membership tier but can overnight there. Under their bylaws, children who are direct descendants can be independent members at age 18. Spouses and stepchildren can become members only if the membership votes them in.
With only about a dozen primary members (two of the patriarch’s four children and their spouses, three of the patriarch’s 12 grandchildren and their spouses, and two great-grandchildren), there is no concept of booking exclusive time at the cottage. “There is no mechanism, even, to book time—we expect it to be used by multiple groups,” says one grandchild and board member, Jim, 46. “It really is a close-knit group.” In fact, families can leave their belongings on designated shelves in the cabins and kitchen from weekend to weekend. “If there is not enough room in the cabins, people sleep in tents, so we have never had to say that people can’t come up.”
However, he recognizes that the next generation of great-grandchildren number some 17 already, most of whom are not yet primary members, and questions of booking time in advance may arise in the future. But it is unclear when the crunch might arrive. Many family cottage compounds find that the cycles of lower use, when the youngest generation is comprised of kids in their late teens and early 20s, combined with natural attrition, mean that an unmanageable demand does not materialize as soon as expected. For example, of his four siblings only Jim is a primary user.
Eventually, demographics can force the need to sell such compounds—too many members and too little space. At that point, according to Arthur Drache, whose law practice specializes in the tax treatment of non-profit organizations, there would be no taxable capital gain on the property, because it is held by a non-profit. However, if the board of directors voted to wind up the non-profit, the capital would be distributed to the current members, who would each have to pay capital gains tax on half of the gain at their individual marginal rate. The members could, however, also claim a refund of the membership fees they personally paid throughout their lifetime from the proceeds of the sale of the cottage and that refund would be tax-free.
An alternative plan to selling the property, suggests Drache, would involve a change to the membership bylaws, delaying children’s eligibility to become independent members until their parents’ death—meaning that each family unit would have to work out its own sharing of allotted time at the cottage.
Clearly, for this communitarian scheme to work, members need a solid set of bylaws establishing rules. One person needs to make sure that the non-profit files a tax return each year, even though it would report no income. Non-profits also have to be careful not to subsidize members who are unable to pay their dues, or be in danger of losing their special tax status. Therefore, a means to enforce non-payment of dues is essential. One option, however, is to pay less financially secure members for maintenance work.
One downside of a non-profit is that a renters’ mentality can set in, allowing maintenance to slip, despite the best efforts of the board’s maintenance committee. The Kawartha Highlands cottage members have stalemated several times on whether or not to replace the boathouse, which one member admits is an eyesore. “People seem worked up about an issue one summer,” says Jim, “but by the time the next summer rolls around, they mellow and the issue goes away.”
Situation: Capital gains tax has been “paid” up to 1995 from the mother’s $100,000 lifetime capital gains exemption
Solution: Transfer it to all the children now, with a co-ownership agreement between the children to avoid disagreements
Mary Wornoff was 72 when she gave her modest, two-bedroom 1940s log cottage on Green Lake, near Renfrew, Ont., to her five children. It was 1994 and she wanted to crystallize the property’s capital gains before the federal government phased out individuals’ lifetime $100,000 capital gains exemption. Her lawyer advised her to see if the two children who were living in the United States, especially the one farthest away in California, might be content to sell their interest in the cottage to the other three, given the cabin’s small size and the limited number of usable summer weeks due to blackflies: just eight weeks during an average summer. But none of the five wanted to be excluded from their cherished outpost on the rocky granite point, where the water is so clear that the lake bottom is almost always visible. “It’s our American siblings’ only link to the family now,” says Tom Wornoff, 48, a brother who lives in Peterborough, Ont. “The cottage is the one thing that holds the family together when you’re all scattered.” Indeed, Wornoff says that the children have come up with the idea of allowing the American residents to bank unused time at the cottage.
The Wornoffs are full of great ideas about how to share a cottage—a template that other cottagers could use. Tom and his wife, Rosie, drafted a co-ownership agreement for his siblings to consider and for their lawyer, Peter Lillico, to review and draft into proper legal language. It includes several useful clauses: that the cottage can be sold to a third party only with unanimous consent of all the owners; that if one sibling wishes to sell to the others, the others can issue a promissory note and pay in five equal installments over five years without interest; that all expenditures must be approved by a majority of the owners; and that none of those prized cottage contents, such as wicker tables or birchbark lamps, shall be disposed of or replaced without the written consent of the majority. “Some of us might have an attachment to an old chair,” explains Tom.
The Wornoff siblings particularly value the history of the cottage—how their mother built it when she was still young and single to avoid losing her foothold in that part of the wilderness when the local graphite mine closed and put her father and brothers out of work. She bought the land for $25 and built the first cottage on the lake. Today, it is still rustic—no electricity, running water, or telephone—but is worth perhaps $70,000. Annual maintenance costs run only about $500 and property taxes just $500. Until her death, all the siblings will be carrying the shared costs on their own, and allowing her to spend as much time as she chooses at the cottage, even though she did not keep a life interest in the property. Upon her death, a trust fund of $10,000 will be established from the proceeds of her estate to help fund ongoing costs and maintenance.
Tom Wornoff’s generation already has plans for their children’s generation. Offspring will be added as tenants in common as they come of age—a move that will lock in their legitimacy to be there, even though it may trigger more capital gains as a share of the property transfers to them.
Situation: Small cottage, no room to expand, the children have different levels of attachment to the property, an urgent need for renovations
Solution: Transfer the cottage to one committed child now while retaining a life interest for yourself
When Wanda Gral’s husband died in 1995, the 67-year-old waitress already owned the family cottage outright, but decided to transfer it to one of her three children: the one who was most interested and most financially committed to managing and improving the property. That was not her oldest son, then 46, or his 41-year-old brother, but her unmarried 31-year-old daughter, Judianne, who had been planning to pay for major renovations to the cottage. “I wanted to make sure the cottage stays in the family,” says Wanda. “I wasn’t sure if my oldest son might want to sell it. And Judianne has put so much into it.” The other son rarely used the cottage because of his back problems. Judianne herself is deeply attached to the cottage because of her love for her late father, who was an avid fisherman and cottager. “Maybe part of me thinks I would lose part of my father, if I lost the cottage,” she says.
The Grals’ solution is one that many estate-planning lawyers urge parents to consider. “Our basic thrust is to make some hard decisions about who should receive the cottage, rather than trying to share it,” says David Currie, a lawyer with the law firm of Thoms & Currie in Huntsville, Ont. “It’s easier on everyone involved for the parent to make the unpopular decision. And all the children have different means and attachments to the cottage.” However, as lawyer Peter Lillico points out, parents who want to leave each child a roughly equal share of the estate have to plan carefully. Giving the cottage to one child and leaving the remaining two-thirds of the estate to the other two at death, for example, may ultimately be inequitable if the two who receive the remainder have to pay the capital gains tax on the cottage from their share of the estate.
In the Grals’ case, the family was dealing with an 18 ft. wide cottage with visible lean on a 25 ft. wide lot on Orr Lake, between Barrie and Midland. Although it has three bedrooms, it was not well-suited to extended family use. The cottage cost only $2,800 in 1949, when Wanda’s husband bought it for her as a birthday present. When Wanda transferred the cottage to Judianne in 1995, the cabin was valued at roughly $50,000. She paid capital gains tax on deemed disposition of the property to her daughter and, when she dies, no further capital gains tax will need to be paid until the cottage passes out of Judianne’s hands. Since she retained a life interest in the property, her name remains on the deed and she can continue to use the cottage. Furthermore, it cannot be unilaterally sold by Judianne. Wanda also protected the property from any potential future claims from a divorcing spouse by having her lawyer document that the cottage was a gift.
Wanda, who has already been very generous with her two sons, was not concerned about the impact of her cottage decision on the other children. She had already invested in the house of one son, and the one with back problems lives at home with her. Both of them will eventually share in the proceeds from the sale of the family home on her death. And she was worried that Judianne’s personal labour on the cottage might not be compensated if a co-owning sibling wanted to trigger a sale. “That girl has gone up and stripped the roof and reshingled it herself, with her fiancé,” says Wanda. Since 1995, Judianne has also installed a septic system, a bathroom, and siding, and made other improvements. “This is my dream place,” says Judianne. “It’s something I can’t lose.”
This article was originally published on May 17, 2004