As summer fades and families prepare to close the cottage for another season, it’s important to remember that these second homes aren’t merely a place to relax and make memories across generations. They can also be a very substantial—and highly emotionally charged—asset in a family’s financial portfolio, presenting a host of financial, tax and governance challenges.
These issues have evolved and increased in complexity in recent years. Why?
Cottages have traditionally been relatively modest properties to escape the city or suburbs. They were usually smaller cabins, many purchased decades ago for a fraction of today’s values—weekend retreats or affordable places to spend a family vacation. But over time, especially in coveted regions such as Muskoka, the Kawarthas, Haliburton and Prince Edward County, cottage values have skyrocketed.
During the COVID-19 pandemic, this trend accelerated at an unprecedented pace. Many urban residents, seeking refuge from social distancing and other restrictions, wanted space in the country, thereby driving demand for waterfront and rural properties to historic highs. In some cases, older cottages in need of significant upgrades were sold for far more than $1 million, with custom-built replacements pushing valuations substantially higher. Although prices have moderated in the past one to two years, they remain far above the levels families would have paid when these properties were originally purchased.
This appreciation has boosted the net worth of longstanding cottage property owners. But for many, it’s also created complications. The reason: Rising values create exposure to higher capital gains tax when the property is eventually sold or transferred, whether during an owner’s lifetime or through their estate. Families who may not consider themselves wealthy by conventional standards often find themselves grappling with unexpected tax bills tied to their cottage. If these liabilities are unfunded, the property may have to be sold or the inheritors will be forced to take on debt to pay taxes owing.
The tax implications of the family cottage: What owners often overlook
Property owners in Canada can leverage the principal residence exemption on their primary residence, which shields it from capital gains tax. Cottages, however, are generally categorized as secondary properties. Owners who have seen substantial appreciation over decades may face significant capital gains tax upon sale or transfer if the cottage is not designated as their principal residence.
Some families attempt to mitigate this by designating the cottage as the principal residence for certain years, particularly if its appreciation outpaces that of their city home. But this strategy can be risky, potentially creating unexpected tax burdens. Careful planning with the advice of a Chartered Professional Accountant with tax expertise is essential for determining the most tax-efficient designation. We’ll explore the tax considerations of cottage ownership in greater detail in our next blog.
Family governance and succession challenges
Beyond tax and accounting matters, the cottage often raises sensitive governance questions. When a property is shared among siblings, extended family, or across generations, disagreements can arise about usage, expenses or future intentions for the property. That can be exacerbated when siblings squabble or a divorce disrupts family harmony.
Many families attempt to resolve these issues informally, using spreadsheets or scheduling apps to allocate time fairly. While this can work in the short term, challenges often emerge as family structures grow more complex. Some approach the cottage almost like a fractional ownership arrangement, where governance, maintenance and financial contributions are clearly defined. Without a plan, disputes can escalate, jeopardizing both the property’s future and family relationships.
A well-crafted cottage agreement can go a long way toward avoiding this sort of conflict. Such agreements outline responsibilities for expenses, rules for booking time, expectations for upkeep and a plan that outlines access rules and ownership if the property passes to the next generation. These agreements should be reviewed periodically as circumstances evolve.
There are also estate planning concerns. When the original owners pass the property to their adult children, it’s not uncommon for one or more heirs to want to keep the property, while a sibling prefers to sell. This can set the stage for a costly scenario where one sibling is forced to buy out the others to keep the property, or a running conflict over whether to retain or liquidate the asset. To say this can be a highly emotional process would be an understatement.
Balancing cottage enjoyment with proactive planning
While the cottage is a treasured family institution, it’s also a financial asset with real consequences if mismanaged. The key is to address tax and governance issues proactively rather than reactively. It’s important to work with your accountant, lawyer and other financial advisors to map out your cottage’s eventual sale or succession.
That involves a range of proactive measures including maintaining detailed records of any capital improvements to support cost base adjustments (which can help to minimize future capital gains liabilities), formalizing ownership and usage arrangements through written agreements to mitigate the risk of family conflict and having transparent discussions about ownership and succession plans.
With a strategic approach, families can preserve the memories and the asset, ensuring that the cottage remains a source of joy rather than tension. Closing the cottage for the season may feel like the end of summer, but it can be the start of a process of understanding and managing its place in your broader financial plan.
Tony Sokic, Managing Partner
For assistance with your high net-worth tax, accounting and strategic financial needs, contact us today.
