Cash in the cabin?

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This article was published 15/07/2023 (814 days ago), so information in it may no longer be current.

For many Manitobans, the family cottage is their happy place.

But what if that piece of paradise is now a source of stress?

That might be the case for some owners in the last year who have borrowed to purchase a recreational property in the last decade or so.

“It’s just more expensive today to own a cottage than it has been in the past and people are feeling it for sure,” says Robert Coruzzi, regional vice-president of wealth management for Meridian Credit Union in Ontario.

“With increased interest rates, people could be seeing rising payments on both their primary residence and the cottage.”

According to a recent survey by Re/Max, 11 per cent of Canadians own a cottage with about the same amount intending to purchase a recreational property in the future.

“A lot of people bought during COVID because they were going to do the whole work from home thing,” says Carol Willes, director of estate planning with BMO Private Wealth in Ottawa.

In Manitoba, the average purchase price for a cottage is about $263,000, a recent Royal LePage survey found, which added that many would-be buyers are holding off “amid evolving economic conditions.”

At the same time, some current owners may be considering selling due to the current economic conditions.

That is more likely the case for those who took on a mortgage in the last few years to purchase a cottage.

Most certainly, they stress-tested their ability to do so in their overall budget.

If they were taking on a mortgage for the purchase, they would have also had to undergo the federal stress-test to ensure they could endure higher interest rates, which had been at near historical lows only about a year and a half ago.

At the time, the stress-test benchmark rate was 5.25 per cent — which seemed fairly high when mortgage rates were running 2.25 per cent. Today, some of those borrowers who passed the test back then could be facing mortgage interest rate costs higher than 5.25 per cent, Coruzzi says.

“Maybe they leveraged their primary residence to purchase a cottage and are now money-stressed as a result?”

While individuals can look at solutions like short-term rentals to generate income to help with costs, “first and foremost, these individuals need to build a budget to provide financial clarity,” he adds.

A good person to turn to for help is a financial planner.

“A financial planner can tell you if you really face a problem with your cash flow and debt,” says Christine Van Cauwenberghe, head of financial planning at IG Wealth Management in Winnipeg.

In many cases, a planner can analyze your cash flow and find savings so you are better able to manage the costs of the cottage, she adds.

“You don’t want to make a rash decision to sell a property when you could really afford it,” she says.

In some instances, however, selling the property is the best way to improve a family’s financial position.

One big wrinkle is, especially if the asset has been owned for many years, are potential taxes owing upon its sale (or transfer to another family member).

Any gain in its value since the cabin was first purchased could be subject to taxation on 50 per cent that increase, minus costs for improving the property over the period of ownership and certain Canada Revenue Agency exemptions.

Yet, tax issues are typically not on the mind of financially stressed families who may be highly leveraged with mortgages, now with increasing costs, on their home and cabin.

And it’s not just families who recently purchased a cabin that could be stressed. Retiring individuals also may feel the pinch.

“If you are getting to the point where you’re on a fixed retirement income and you are seeing expenses escalate to the point where it’s getting really tight and other people are using it and enjoying the property, it’s fair to ask if they can share in the costs,” Van Cauwenberghe says.

“And if they can’t, that is a harbinger of whether they will be able to carry those expenses should they inherit the property.”

Again, this speaks to the value of working with a financial planner. It also points to the need to involve adult children in the discussion, who may want to continue using the cabin and inherit it.

This can lead to more in-depth talks about tax strategies like creating a trust, Coruzzi says.

“One of the benefits of having a trust is you’re able to transfer the cottage to your kids, the beneficiaries and pay the capital gains taxes today,” he says. That way, your children do not face a potentially big tax bill upon your death—though taxes can still apply on growth of the asset inside the trust, he adds.

Of course, a retiree still needs the savings to pay the taxes owing prior to putting the cabin in trust.

“Every arrangement you have for the cottage has some advantages and some disadvantages, trusts included, so you have to figure out what advantages you want and what disadvantages are manageable,” Willes says.

A driving factor is indeed potential taxes owing on the asset once it changes ownership, and how to pay for those.

But so too is fairness among children.

For example, one child may want to use the cabin while the others have no desire at all.

In turn, as the parent, you may want your estate designed tax-efficiently to ensure assets are split fairly.

All of this speaks to the benefits of planning sooner than later with professional help, Willes adds.

“These are all things we walk through with clients when thinking about this bundle of wax called the cottage.”