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Consider the easy way out when dealing with the cottage

There's nothing like Grandpa spending a little time with the grandkids, teaching them how to fish. This past week, my kids spent some time with their Papa John doing just that.

"What did you learn from Papa?" I asked after they returned with quite a few fish to show for their efforts.

"It was easy Dad!" Winston said. "All you have to do is go to that trout farm up the road and pay the man some money. I caught four big fish in five minutes!"

So my kids now think that all fish swim in schools of a billion, crowd together just beneath your line, are starving all the time, and can be caught with just about anything that will stick to your hook. Well, there's something to be said for doing things the easy way.

When it comes to dealing with your cottage in your estate planning, sometimes the best approach is taking the easy way out.

The issues

Consider Ruth. Her husband Carl died a few years ago. Ruth is now contemplating what to do with the cottage. She doesn't use it much any more. Her son Mark goes up all the time with his family, but Ruth's two daughters don't spend much time there at all.

The cottage means the most to Mark, but Ruth wants to leave her estate to all three kids equally. She has no other assets to divide up when she's gone. Now, most accountants and lawyers will agree that leaving real estate to all the kids equally can be a recipe for disaster.

When the kids own the cottage jointly, they'd better be able to agree on everything, including, among other things, sharing of time, paying for upkeep, and deciding when to sell. This will be tough for even the closest families, and hard feelings almost always result.

The options

What are Ruth's options?

Sell it now. Ruth could sell now if she wants to avoid paying for upkeep of the cottage. She could then gift the proceeds to her kids today. She may even give Mark the right of first refusal to buy it. Her principal residence exemption (PRE) could shelter the sale from tax.

Gift it now. Ruth could gift the cottage to all three kids today. This gift will be treated like a sale for tax purposes, but her PRE could shelter the transfer from tax. She could act as mediator to resolve disagreements while she's alive. But what about after she's gone? Disagreements can arise.

Transfer to a trust. Ruth could transfer ownership to a trust. This is not much different for Ruth, however, than gifting the cottage today and maintaining control and decision-making powers while she's alive, except there are added costs and tax complexities.

Transfer to a non-profit corporation. This idea creates an effective governance structure for the cottage, but isn't for everyone because it adds costs and complexity. See my article dated June 29, 2002, at timcestnick.com.

Leave it in your will. Ruth could leave the cottage equally to her kids in her will with the requirement that the place be sold and the proceeds be divided equally. She could give Mark the right of first refusal to buy the place.

At the end of the day, the easy way out may be best. That is, to sell the cottage today, or make sure it's sold after you're gone, and divide the proceeds. If one child seems like the natural person to own it, give him or her the right of first refusal to buy it at fair market value.

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.tim@timcestnick.com

© The Globe and Mail

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