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Case Study #1: Owning with a sibling
Goal: clearly define financial responsibilities
Solution: set up ground rules for expenses in a sharing agreement
The year was 1976, and you might wonder which was more exciting for John Potwin: the birth of his third son, Mike, or the purchase of a water-access 20-by-30-foot log cabin by the Mississagua River in Ontario’s Kawarthas.
When John died, 40 years later, he left the cottage to his wife and their four children, including Mike and his younger brother, Rob. “It was sort of ‘You guys sort it out, I don’t want to pick favourites,’ ” Mike says. “We talked about it, and just where people were in their lives, it made sense for Rob and I to purchase the property from the estate.”
To make the process fair, “one of us floated the idea of getting two appraisals done—one by someone Mike and I picked, and one by someone the others picked—and we took the median,” explains Rob. “So there was no room for anyone to come back and say, ‘Hey, I don’t like the way the price worked out. I want a do-over.’ ”
When the cottage closed in July 2017, top of mind for the brothers was outlining their financial responsibilities, such as maintaining a reserve and dividing up the expenses. So they created a cottage sharing agreement, which set out ground rules. For example, if they decide to put in a new dock, they both have to agree on how much money each will contribute. And both must agree in order to go ahead with a project once its cost estimate goes above a certain amount. One owner can still proceed, as long as he pays for the extra expense. “Mike and I have the added benefit of being close, and we’re like-minded in the sense that we’re both unemotional, feet-on-the-ground, reasonable business people,” Rob says. “We’re used to compromise and negotiation.”
Since it was just the two of them sharing the cottage, Mike and Rob decided not to put it into a trust. This means that if either brother has a marital breakdown, and a division of family assets is necessary, the cottage will be in play as an asset. But the agreement specifies that ownership can only be transferred to a linear descendant of their father, so a divorcing spouse can’t take ownership. “She would get paid out,” Mike explains.
Should one of the brothers want to exit the partnership, the agreement specifies a clear right of first refusal period for the other sibling. “If he chooses not to or doesn’t have the means to purchase, eventually a market sale will be triggered,” explains Mike. “But the other person has some time to figure out how to do it on his own.”
The Potwins’ recommendation to other cottagers is to get professional advice and to not get too complicated. “If you over-engineer things, you’re creating opportunities for conflict. I really feel strongly about this, that the fewer opportunities for conflict the better,” Mike says. “Try to work things out, and then you have the sharing agreement to revert to as a Plan B if conflict does arise—as opposed to putting every little thing in the agreement. That’s not the point of owning a cottage.”
Case Study #2: Sharing, then selling
Goal: sort out the valuation and management of cottage shares
Solution: work out a sharing agreement that provides a mechanism for selling
The tract of lush, green rainforest surrounding 62-year-old Ian Gordon’s hometown of Terrace, B.C., couldn’t be more different than Georgian Bay’s pink granite islands, but his heart is drawn to both places. He’s been living in B.C. since his twenties, when he arrived “for one year.” But he returns most summers to the family cottage north of Pointe au Baril, Ont.
Ian’s late father bought an island there (for a whopping $90) in the 1950s. Then, in the 1970s, recognizing that property values on Georgian Bay were climbing, he added all six children to the title. It was a clever move. When Ian’s mother, by then a widow, died two years ago, her estate faced a capital gains tax hit on the property, which was worth about $400,000. With six other owners, however, the CGT only applied to her one-seventh share.
The cottage is still valued on a six-share ownership. When two of the siblings wanted out, another one bought their shares. That left three siblings with one share each and the fourth with the other three. They decided that shares would be evaluated at 75 per cent of their market value should one of the shareholders want to give up ownership. Exiting shareholders will receive the additional 25 per cent only if the remaining owners sell the cottage within the following two years. The rest have the first right of refusal to buy out their sibling’s share and then have two years to pay. (Using a discounted value as an exit strategy—the amount depends on the wishes of the group—reduces the financial strain on the remaining siblings and makes it easier for them to come up with the buyout funds so that the cottage doesn’t have to be sold. It’s also likely that the remaining owners will see the buyout as a “good deal,” thus lessening the chances of the cottage going on the market.) The same agreement holds if a shareholder dies. The remaining shareholders would pay out at 75 per cent to the estate. All of this is enshrined in the cottage sharing agreement.
Owners pay an annual fee for each of their shares to cover operating costs, which total between $4,500 and $6,000 a year. Thus, the sibling with three shares pays three shares’ worth. “We all agree on that,” Ian explains, “because it’s also clear that if and when the island does sell, more money goes to the one with more shares.”
Sadly, that sale is likely to happen with the next generation, a result of lack of interest, increasing costs, and distance. “What used to be a relatively inexpensive recreational property is now no longer,” Ian says. “What used to be a $300 tax bill is now $4,000.” His own two children are separated from the cottage by geography and jobs that keep them in B.C. But since an important part of the sharing agreement was to establish a mechanism for selling, the family will be ready when that happens.
Case Study #3: Prepping for the grandkids
Goal: formalize a succession plan to keep the cottage in the family
Solution: set up a sharing agreement with provisions for passing the cottage to the grandchildren
“To be honest, if my husband hadn’t come down with the diagnosis, I would still be thinking about it,” says Mary Lynne Holton, 67, about the Canonto Lake cottage in North Frontenac, Ont., that was gifted to her by her mother. Recently, she and her husband, Jim, 71, received the devastating news that he was in the early stages of dementia. “You always think if something happens to you, the other person will be able to manage. But I couldn’t leave the cottage to him to take care of.”
“My father always wanted the property to be a family cottage,” says Mary Lynne. So after Jim’s diagnosis, she talked with Peter Lillico about creating a cottage sharing agreement that would formalize a succession plan for her three daughters after she died. “I thought it would be a slam dunk,” she says. For example, because of the distance, she didn’t think the daughter in B.C., who’s in the navy, would want to be part of the ongoing cottage ownership. That left a daughter in Ottawa and one in Toronto. “But Peter said you have to see who can afford it and who is interested in it.” Turns out, all the girls were interested.
Mary Lynne had also decided that the cottage would pass directly from her daughters to the grandchildren, meaning the girls’ spouses would have no shares, in the same way that Jim has never been an owner on the property that was passed to Mary Lynne from her own parents. But the one daughter currently with children was concerned that if something happened to her, and her children were too young to take over, her husband would have no influence. So it was agreed that she could leave her interest in the cottage to her husband by way of her will. It will still pass from him to the grandchildren—an elegant solution.
Everyone—including the grandkids when they take over—is required to abide by the cottage sharing agreement, which governs usage and costs. A key clause addresses what happens when a shareholder is in default of payment for such things as annual expenses, taxes, and upkeep. The other owners can approve the default or require a remedy. If the remedy, such as payment, isn’t forthcoming, use of the cottage can be revoked. The agreement also provides for a shareholder’s ability to sell, but the others have first right of refusal.
Mary Lynne admits to being relieved that the agreement is in place, in part because of the strong ties her family has to the cottage. “We’ve been to quite a few funerals in the last year and a half. They rarely mention the family home in the service, but they always mention the cottage. There is a lot of emotion around the cottage.”
Case Study #4: All in the (big) family
Goal: Eliminate probate and reduce capital gains taxes
Solution: Set up a joint partner trust with a sprinkling inheritance trust
Like many cottagers, George and Dana Bachman consider their retreat “the consistent place for family.” Over the years, George’s work in the military dropped them in cities across Canada and overseas. But they always returned to the five-bedroom cottage on Cameron Lake, Ont., and now they live there full time. All four of their children and nine grandchildren love to visit, preferably at the same time, and they all want to continue to remain involved with the cottage.
The Bachmans, now in their seventies, bought the cottage in 1986, and it became their principal residence in 1996. Thanks to the principal residence exemption, they’ll only pay capital gains tax on the increase in value between 1986 and 1996. “We had two goals,” says George, “to eliminate probate and to tear down the capital gains.”
The solution was a joint partner trust, with Dana and George as co-trustees who will continue to share responsibility for and control of the cottage until their deaths. They have arranged for two of their sons to be promoted to trustees should one of the parents die (when Dana dies, one son will represent her interest; when George dies, the other son will step up). When both die, a cottage sprinkling trust kicks in, with all four kids as trustees and the grandkids as beneficiaries.
Before setting up the cottage sharing agreement, lawyer Peter Lillico asked the family members to fill out a “scoresheet” that captured each one’s vision about the cottage and how it should be used and managed. It posed questions such as how interested each was in owning the cottage, how much they expected to use it, to what extent they could contribute financially, and how much they were prepared to share responsibilities and cooperate with their co-owners. Then he, George, Dana, and all four children got on the phone together. “It was really good doing the conference call, because things came up and got addressed,” Dana says. “We listened while the kids talked it through.” The children agreed on a consensus rule for decision-making, and then gave one of their brothers an extra vote to break a tie.
A key part of the agreement is that “the even-handed rule does not apply,” says Dana. So if the cottage is worth, say, a million dollars, they are not each entitled to a quarter. Any one of the children can decide not to accept the gift and not to be a part of the agreement, but they can’t expect any compensation. “The general rule for trusts is that the trustee must keep an ‘even hand’ among the beneficiaries, in other words not unfairly favour one beneficiary or class of beneficiaries over others,” Lillico explains. The sprinkling trust expressly relieves trustees from the application of this rule.
“We found it to be a good family experience. It raises questions that you don’t normally address while the parents are still alive,” Dana adds. “We’re really lucky how well everyone gets along. That’s one reason we knew the family trust thing would work.”