Families spend years worrying about who will get the cottage and almost no time on whether they will be able to afford to keep it. The second question is usually the one that decides the outcome.
The deemed disposition
Canada has no estate tax, but there is something with a similar effect. On death you are deemed to have disposed of your capital property at fair market value — even though nothing was sold.
For a cottage bought decades ago, the gain can be enormous. A property purchased for $60,000 in the 1980s and worth $700,000 today produces a capital gain of $640,000. Half of a capital gain is taxable, added to income on the final return, and the resulting bill commonly runs well into six figures.
That bill is due with the final tax return. If the estate has no cash, the property has to be sold to pay it — which is precisely how families lose a cottage they all wanted to keep.
The principal residence exemption
You can designate one property per family unit per year as your principal residence, sheltering the gain on it. If the cottage has appreciated more than the city house over the same years, designating the cottage for some years may reduce total tax.
This is a real calculation, not a rule of thumb, and it needs an accountant with the numbers. But the possibility is worth knowing about, because families often assume the exemption automatically attaches to the house they live in.
Options families consider
Sell it during your lifetime. Simplest, and emotionally the hardest.
Transfer it to children now. This triggers the deemed disposition immediately at fair value, so you pay the tax while alive. It caps future growth in your hands, but the tax is due now and you lose control of the property. It also exposes the cottage to the children's creditors and matrimonial claims.
Put it in a trust. Can work for control and succession, but a trust faces a deemed disposition every 21 years, which needs planning.
Fund the tax with life insurance. Frequently the cleanest answer. A permanent policy pays a tax-free death benefit exactly when the tax bill arrives, so heirs can pay it without selling.
Why insurance fits this problem well
The need is permanent — the tax will be triggered whenever you die, whether that is at 70 or 95. Term insurance that expires at 80 does not address it.
The amount is also reasonably estimable. Work out the likely gain, apply the inclusion rate and a reasonable marginal rate, and you have a target. Review it periodically, since property values move.
Many couples use a joint last-to-die policy. Because a transfer to a surviving spouse generally defers the tax, the bill typically arrives on the second death — which is exactly when this policy pays, and it costs less than two individual policies.
Before arranging anything, find out whether your children actually want the cottage. Adult children who have moved provinces, or who cannot afford the upkeep and property taxes, often feel unable to say so. Planning elaborately to preserve something nobody wants is a common and avoidable mistake.
The part that is not about money
Where multiple children inherit jointly, they must agree on maintenance costs, scheduling, improvements, and what happens when one wants out. Co-ownership agreements exist for exactly this and are worth having drafted while everyone is on good terms.
Consider also whether equal is fair. If one child will realistically use the cottage and another will not, leaving the cottage to one and equivalent value — often funded by insurance — to the other can prevent years of friction.
What to do
- Establish the adjusted cost base — original price plus capital improvements. Find the receipts now; they are hard to reconstruct later.
- Get a current valuation and estimate the tax.
- Ask your accountant about principal residence designation across your properties.
- Ask your children honestly whether they want it.
- Fund the liability, usually with permanent insurance, if keeping it matters.
- Document the arrangement — a co-ownership agreement if more than one child inherits.
I can size and arrange the insurance and work alongside your accountant and lawyer on the rest. Doing this early is considerably cheaper than doing it at 78.
How the tax is actually calculated
At death you are treated as having sold your capital property at fair market value. For a cottage that has been in the family for decades, the gain can be enormous, and half of a capital gain is included in income.
| Step | What goes in |
|---|---|
| Proceeds | Fair market value at death |
| Less: adjusted cost base | Purchase price, plus capital improvements, plus buying costs |
| = Capital gain | The growth over the whole period of ownership |
| Taxable portion | An inclusion rate set in legislation, applied to the gain |
| Tax payable | At the deceased's marginal rate in the year of death |
I have not printed an inclusion rate or a tax rate here, because both are set by legislation and have been the subject of recent change. Check the current rules with CRA or your accountant. What does not change is the shape of the problem: a long-held cottage produces a large gain, and the bill is due with the final return rather than when the heirs eventually sell.
The receipts that are worth thousands
The adjusted cost base is the one number the family can legitimately increase, and it is routinely understated because nobody kept the paperwork.
Capital improvements add to the cost base. A new roof, a septic system, a boathouse, an addition, a well, winterising — these are improvements, not repairs. Painting and fixing a dock are maintenance and do not count. Legal fees and land transfer tax on the original purchase count too.
Practical advice: start a folder now, even if the purchase was in 1985. Reconstruct what you can from old cheque stubs, contractor records and photographs. Every documented dollar of improvement reduces the eventual gain, and the CRA can ask for substantiation.
Why the principal residence exemption rarely rescues a cottage
A family can designate only one property per year as its principal residence. If the city home has grown in value more than the cottage — which is usually the case in the GTA — using the exemption on the cottage means giving it up on the house, creating a bigger problem than it solves.
The calculation is genuinely complex, involves a per-year designation, and should be run by an accountant with both properties' numbers. It is occasionally the right answer for a family whose cottage has appreciated far more than their home. It is not the default.
What families usually consider, and the catch in each
| Option | The catch |
|---|---|
| Transfer to the children now | Triggers the tax immediately, at today's value, out of pocket |
| Add children to title jointly | Partial disposition now; exposes the cottage to their creditors and divorces |
| Leave it in the will and hope | Heirs face a bill they often cannot pay, so it gets sold |
| Sell it yourself | Clean, but ends the thing you were trying to preserve |
| Insure the liability | Costs premiums, but the money arrives exactly when the bill does |
Why insurance fits this particular problem
The tax bill has two features that make insurance unusually well suited: it is triggered by a death, and it is payable in cash at that moment. Very few financial problems match an insurance payout so exactly.
A joint last-to-die policy on both parents is the common structure. It pays when the second parent dies, which is normally when the cottage passes and the tax falls due, and it is cheaper than two separate policies because the insurer is pricing the later of two deaths.
Two practical notes. Estimate the liability with an accountant rather than guessing, and revisit it every few years — cottage values move, and a policy sized to a 2015 valuation may be well short. And consider who pays the premiums: where the children will inherit, it is not unreasonable for them to contribute, since they are the ones the policy protects.
The part that is not about money
Funding the tax solves the forced sale. It does not solve four siblings disagreeing about whether to keep it, who gets the August long weekend, who pays for the new roof, or what happens when one of them wants out.
Families who keep a cottage successfully usually write something down while the parents are alive: a co-ownership agreement covering costs, scheduling, decisions and an exit route for anyone who wants to sell their share. It is an awkward conversation and far less awkward than the one that happens without it.
I am not a tax advisor or a lawyer — the valuation and the agreement need an accountant and an estate lawyer. What I can do is price the insurance that funds the bill. Get in touch, or see estate planning basics for how this fits the wider picture.
