Real Estate

Family Harmony and Legacy: Incorporating Your Cottage to Protect and Preserve

Wednesday, July 17, 2024

A family cottage is a source of joy where families spend some of their most cherished times.  They can become a powder keg however when it comes to estate planning.    

For example,

  • Generation 1 (G1) includes 3 adults who inherited the cottage from their parents.  
  • G1 wants to pass the cottage on to Generation 2 (G2) which consists of 7 adult children.
  • Generation 3 (G3) already includes 6 children and is steadily growing.  
  • Not all of the children in G2 want to own the cottage but they expect to be equalized for the value of the portion of the cottage that they are inheriting.

By leveraging the expertise of a financial planner, accountant, and lawyer, families can create a robust strategy to preserve their cherished cottage for generations to come.

Financial Planner Perspective

Establishing a corporation to hold a family cottage is a strategic move to ensure its preservation and enjoyment for future generations. This approach provides several benefits:

  1. Asset Protection: Placing the cottage in a corporation shields it from the personal liabilities of family members, reducing the risk of losing the property due to financial difficulties or legal claims.
  2. Simplified Ownership Transfer: Shares of the corporation can be easily transferred to family members without the need for complex legal procedures, ensuring smooth succession planning.
  3. Tax Efficiency: By incorporating, the cottage may qualify for certain tax advantages, such as the ability to deduct maintenance expenses and potentially lower capital gains taxes when the property is eventually sold.
  4. Centralized Management: A corporation allows for structured governance, making it easier to manage decisions regarding the cottage's use, maintenance, and improvements through a board of directors or designated officers.
  5. Family Harmony: Clear guidelines and a formalized structure can help prevent disputes among family members by establishing defined roles and responsibilities.
  6. Insurance:  Can be used to finance the equalization of the cottage value for an owner’s estate plan for their beneficiaries

Accountant Perspective

From an accounting standpoint, transferring a family cottage into a corporation involves several key considerations:

  1. Valuation: Accurately valuing the cottage at the time of transfer is crucial for determining the share distribution and potential tax implications.
  2. Tax Implications: The transfer may trigger capital gains tax based on the fair market value of the property at the time of incorporation. However, this can be managed through strategic planning and potential deferral mechanisms.
  3. Expense Deductions: Operating the cottage through a corporation allows for the deduction of legitimate business expenses, such as maintenance, repairs, insurance, and property management fees.
  4. Annual Reporting: The corporation will be required to maintain accurate financial records and file annual tax returns, which ensures ongoing compliance and transparency.
  5. Income Splitting (potentially): The corporation can pay dividends to family members, potentially taking advantage of lower tax rates on dividend income and splitting income among family members in lower tax brackets.

Lawyer Perspective

Legally, incorporating a family cottage involves several critical steps to ensure its long-term protection and seamless transfer across generations:

  1. Incorporation Process: Forming a corporation requires drafting and filing articles of incorporation, establishing bylaws, and creating shareholder agreements to define the rights and responsibilities of family members.
  2. Share Structure: Designing a share structure that reflects the intended ownership distribution among family members is essential. This may include issuing different classes of shares to address voting rights, dividend entitlements, and transfer restrictions.
  3. Estate Planning: Incorporating the cottage into an estate plan ensures that the property remains within the family. This involves drafting wills and trusts that specify how shares are to be managed and transferred upon the death of a shareholder.
  4. Governance: Establishing a clear governance framework, including the appointment of directors and officers, is crucial for effective decision-making and management of the property.
  5. Compliance: Ensuring ongoing compliance with corporate laws and regulations is vital. This includes holding regular shareholder meetings, maintaining corporate records, and filing necessary legal documents.

Operating Agreement

Draft a comprehensive LLC agreement that outlines the rules and protocols for family-member owners.

Key provisions to address in the agreement:

  1. Permitted Members:
    • Specify who can be members of the LLC (usually family descendants) and set limits on transferability.
  2. Governance System:
    • Establish decision-making processes related to cottage use and operation.
  3. Member Transfers:
    • Define circumstances and terms for selling, transferring, or terminating a member’s interest.
  4. Financial Obligations:
    • Clearly state each member’s obligation to contribute to maintenance and improvements.
  5. Sharing System:
    • Divide cottage use among family members.
  6. Renting to non-family:
    • Decide whether the cottage can be rented to non-family third parties.
  7. Mortgaging:
    • Address whether the cottage can be mortgaged for financing purposes.

Although these may be challenging conversations to have with family members, it is much easier than trying to figure it out after family members have passed away.  If you are looking for a place to start, please contact us at www.flatironwealth.com and book a time to chat to see if we can help point you in the right direction.

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