Don’t let your dream cottage become a tax nightmare
A guaranteed summer retreat is the dream, right? A space that you can get away to and maybe work on over the years. Or maybe you’re looking to rent the property some of the time? And what about when you’re ready to move on and divest yourself of the cottage? Maybe you want to sell it, or gift it to your child. A second property, whether for personal or income use, comes with a lot of considerations, especially during tax season.
Personal vs. profit
Purchasing a vacation property in Canada doesn’t have immediate tax implications, but there are a few circumstances where you will have to report on your property. If your cottage is exclusively used as a personal vacation property, or if you are renting the property for part of the year with the intention of recovering ownership costs and not of making a profit, then you won’t have to report on your annual income tax return. However, if you plan to rent out the property more than half of the year and expect to make a profit, then the property is no longer considered personal use property and you will have to report it as rental income on your income taxes.
In contrast to your home, your cottage, whether for personal use or for profit, is considered investment property and, therefore, has tax implications that require advance planning. That’s where all that work you’ve done and the improvements you’ve made to the property can have a real impact: if you sell your cottage for more than its purchase price, the Canada Revenue Agency (CRA) will deem that to be a taxable event, triggering the Capital Gains Tax.
What is the capital gains tax?
A capital gain is simply the difference between your property’s original purchase price and its increased sale value. The capital gains tax must be paid on any capital gain when your non-principal residence property is sold.
Do I pay a capital gains tax if I gift the cottage?
Transferring the property to your spouse or common-law partner, while alive or upon death, is considered a roll-over of asset, so the capital gains tax would be deferred until your spouse divests themselves of the property but would need to be paid at that time.
Gifting your cottage to your children would be subject to immediate capital gains tax.
Principle Residence Exemption
You may qualify for the Principal Residence Exemption (PRE) if your property meets these four criteria:
- it is a housing unit;
- you own the property (or jointly own it with someone else);
- you, your spouse, or your children ordinarily inhabit the property; and,
- you designate the property as your principal residence.
A seasonal residence like your cottage can be considered ordinarily inhabited even if you only use it for vacation periods if the primary reason for the property is personal use with no expectation that it will generate income.
A rental property cannot be considered a primary residence and, therefore, does not qualify for the exemption and would be subject to the capital gains tax when you sell the property.
CRA has tightened the PRE reporting requirements and the audit process, so talk to your Assante advisor about your intentions with the property and proper tax planning.
Tax implications for foreign vacation property
If you own a cottage and rent it out in another country, any rental income would be taxable by CRA, and may be taxable in the other country. And, if you sell the property, any capital gain that is taxable in Canada, may also be taxable in the country where the property is located. Talk to your advisor about any tax credits that may be available to offset the Canadian tax amount.
Estate planning for a cottage in a foreign country
Because foreign jurisdictions may have probate, estate or inheritance tax laws that differ from Canada’s, you’ll want to make sure that you have power of attorney and a will drafted in that country so your executor has the authority to manage or sell the property when you pass away.