Cottages and taxes?
Understanding the financial implications of your home away from home
Brian Quinlan of Allay LLP was featured in the December 2022 edition of Costco Connections, written by Lana Sanichar. The article can be found below.
by LANA SANICHAR
The Canadian MoneySaver gets many emails and letters from our subscribers about investing, financial planning and taxation. But the No. 1 question is on the topic of cottages and how the owner’s taxes will be affected when it is time to sell or when it’s left to other individuals after the owner passes away.
To help answer that question, I reached out to Brian Quinlan, CPA of Allay LLP in Toronto and a Canadian MoneySaver contributing author, for his best tips. He highlighted a number of income tax issues to keep in mind.
● A cottage can qualify as a principal residence, so a taxpayer may be able to avoid income tax on the gain when it’s sold. However, cottage owners who also have a city home often choose to use the principal residence exemption to shelter the gain on that property from income tax. When this is the case, the taxable capital gain on the cottage will be subject to income tax. (Fifty per cent of the capital gain is considered the taxable capital gain.) Couples can’t double up on the principal residence exemption by having the cottage owned by one of them and the city home by the other. Spouses or common-law partners need to share the principal residence exemption.
● It is important for cottage owners to keep a running tally of costs in anticipation of having to calculate the gain on the cottage when it is sold. In tax lingo, the cost is referred to as the “adjusted cost base” (or, simply, the ACB). The higher the ACB, the lower the gain, the taxable capital gain and the income tax liability. The ACB calculation begins with the purchase price of the property, including the land transfer tax and the legal fees incurred in making the purchase. The ACB is then increased by the cost of capital improvements related to the cottage property. Examples include a bunkhouse, boathouse, a dock and a septic system. It is important to retain all of the receipts in case the Canada Revenue Agency asks the cottage owners to prove that the ACB is correct. Note that “free labour” provided by the cottage owners—and their family and friends—does not serve to increase the ACB of the cottage property.
● If the cottage is gifted prior to death—to, say, an adult child—the cottage is deemed to have been sold at market value at the time of the gift. The gifter—the parent—will incur a taxable capital gain and a tax liability. However, there will be no cash to pay the tax since there was no actual sale. Here, perhaps, the adult child who received the gift of the cottage, can help the parent out in funding the tax liability.
If a cottage is not sold in the owner’s lifetime, it is deemed sold at market value at the owner’s death (assuming it is not passed to a surviving spouse or partner). A tax liability for the deceased arises on the accrued gain, but there will be no cash to pay the tax since there was no actual sale. The tax liability needs to be funded from the deceased person’s other sources of funds. If there are insufficient funds, the cottage will need to be sold to obtain cash to pay the tax.—Brian Quinlan, CPA