We have just gone through the process of selling a family cottage as part of a generational right of passage. In our case, the cottage was too large and the generational kids did not want to undertake the acquisition. Times have changed as well as the need. The family cottage and land was too large of an undertaking in terms of its size and maintenance. Since one sibling did not want to participate, the other remaining sibling decided to sell it as a going concern.
The entire process was properly planned and the disposition was seem less. With proper and prepared planning, there were no unforeseen roadblocks or errors. The same thing cannot be said for everyone.
While you can’t put a price on quality time spent with family and friends, we have had the misfortune of experiencing a few clients who have had financial issues with the privilege of owning a family cottage. Owning a cottage is not like owning your primary residence.
Owning a cottage is a worthwhile investment, make no mistake – there is a cost associated with it. Regardless of whether you’re scouring MLS listings for your first cottage, or planning your estate for future generations, here are eight financial mistakes that you’ll want to avoid:
The cost of maintaining the property
Mortgage payments aren’t the only expense. In addition to regular upkeep, expect the unexpected in maintenance costs—from a deck that rots, to a roof that suddenly starts leaking.
Taxes and legal fees
Buyers also need to be aware that their property taxes will reflect the market value of the property, which is not necessarily the same as the purchase price. Often property is not properly assessed at MPAC in Ontario for property tax purposes. After sale, the assessed value will likely be increased, resulting in an increase in property taxes.
You’ll also need to take out insurance, which may be more expensive in locations where emergency services are further away, or when the cottage may be vacant for weeks at a time.
The time investment associated with cottage ownership
Getting to and from the cottage, whether by car or bus, can quickly eat into your budget – and your time.
And while renting out your vacation property can be a great way to turn a cottage into an “investment property,” there’s a real cost associated with becoming a landlord, including the time spent finding renters and cleaning it between visits. Wear and tear by renters may also depreciate the cottage’s value.
Co-owning without thinking long-term
When you’re investing in a property with family, a business partner, or friends, you’ll need to set up financial agreements related to upkeep and maintenance. However, keep in mind that people’s interests and financial circumstances may change.
Many times, joint ownership with other family members leads to problems, which can sometimes be contentious. For example, one wants out, but the other does not want to buy them out or cannot afford it.
Keeping track of capital improvements
If you choose to sell or transfer your property, the property value will need to be adjusted, which will include any renovations. Hang on to your receipts and take before and after pictures.
Putting the cottage in the name of your children
While this may be your first impulse, it can lead to complications. In Ontario, cottages are considered family property. This means that if one of your children gets divorced, their spouse may have a claim on it—even if you paid for it.
Instead, it may be advisable to have the property held by a family trust. However, be aware that the rules have been recently amended to eliminate the use of the principal residence exemption on properties owned by a family trust after December 31, 2017.
Tax implications of transferring the cottage
Many think there is no tax payable and just transfer the cottage. However, as of 2016, property disposition—including cottages—in Ontario has to be reported on your tax return. Those who transferred cottages without reporting the gain will potentially be faced with taxes and penalties.
Selling to children for less than market value
While it may be tempting to hand over the keys for a $1, you may end up getting taxed twice. The CRA treats transfer of ownership as being made a full market value—regardless of the price you agree to. Not only will your children need to pay tax on capital gain, you’ll also end up paying tax on the full market value.
The bottomline
The key recommendation we can make is to ensure you engage with the proper professionals before disposing of a family cottage. This would include speaking with your financial advisor, lawyer, accountant and real estate agent as part of conducting your due diligence. The stress and family discourse is tough enough to navigate never mind the real estate process. Making sure you do your homework and are properly prepared before listing the cottage and putting up a for sale sign are steps in Keeping Life Current.
