Reduce the CRA’s tax take
With the price of recreational real estate soaring in the past couple of years, especially in high-demand areas, many long-time vacation property owners are seriously thinking about selling the property, especially if they are close to or in retirement. That could be a good move just now, with mortgage rates rising, and demand starting to cool. But there are a number of important tax implications to be aware of. Here’s a summary.
Capital gains tax
First and foremost is that you’ll have to pay capital gains tax on the appreciation in the value of the property from when you purchased it. That’s because your recreational property is typically not your principal residence. For tax purposes, your “principal residence” is the place where you live most of the time, and is thus exempt from capital gains tax when you sell. But most families can have only one principal residence.
How the CRA calculates the gain
The Canada Revenue Agency calculates the capital gain on the sale of a cottage as the proceeds of the sale minus the cost of selling and the adjusted cost base (ACB). Here’s where things get interesting, especially if you’ve owned the cottage for a long time.
If it’s a multi-generational property, you may be able to take advantage of the “Valuation Day” manoeuvre. This involves assigning an acceptable value to the property as of January 1, 1972, or “V-day.” Parents or grandparents may already have done this, so check the cottage paperwork. Essentially, this means any capital gain before V-day will not be subject to capital gains tax. The V-day value (less improvements made since then) for these types of properties is considered to be the Adjusted Cost Base for determining capital gains tax. That could still be significant, even if you can whittle down the ACB with capital improvements made over the intervening 50 years.
But be sure to document and track all the components of the ACB to prove that they are all bona fide costs and expenses. That should not be too difficult with vacation properties, which are notorious for needing constant maintenance and improvement.
Here’s what the CRA looks for:
- Costs of acquisition. You’ll need proof of the original purchase price or some proof of value if the property was a gift or inheritance. Also, if you made an election to increase the ACB in 1994, you’ll need some evidence of that. (This refers to a now-defunct capital gains exemption for up to $100,000 that applied to capital property, including cottages, and was filed with the taxpayer’s 1994). Other costs of acquisition include such things as legal and inspection fees, land transfer taxes, sales commissions, survey, title insurance, and repairs to upgrade a property that was in disrepair. You’ll have to demonstrate that the original purchase price would have been higher without these repairs.
- Property improvements. These include items not directly related to the building, such as a new water system, well, septic or holding tank, property drainage improvements, fixed decks and docks, and access driveway. These can be included in ACB if they are “new” and not a result of ongoing maintenance, which generally cannot be included in ACB. Receipts are essential.
- Qualifying renovations. Renovations that introduce elements to the structure of the cottage or residence that weren’t there before will generally qualify to be included in the ACB – say, an extra bathroom (plus the fixtures), or a new deck, or even a couple of new bedrooms that made the cottage bigger.
To determine whether the item is an “improvement” or “ongoing maintenance,” the CRA looks at whether the expenses were incurred simply to restore the building to its previous state. So a coat of stain on old siding won’t count, but an upgrade from rotting wood siding to quality aluminum or brick would. New windows, doors, flooring, walls, and upgraded kitchen and bathroom fixtures would all qualify.
Beware transfers to the next generation
Be careful about transferring the title to your kids or grandkids, or holding title in joint tenancy. The CRA will still treat any such transfer as a deemed sale, and still demand its cut in the form of capital gains tax. Holding the property “in trust” might be an option, but then you actually have to create a trust for this purpose. This can be complicated and expensive. In addition, the CRA is highly skeptical of claims for recreational properties held “in trust” where no legal trust exists. Best to get expert legal help in this situation.
If it’s time to sell or transfer the family cottage (or even if you’re contemplating buying one for the first time), consult a qualified financial professional who can help you avoid or mitigate the many legal and tax pitfalls involved. After all, you don’t want that cozy cabin in the woods to turn into a tax trap by the lake.