Since the Covid-19 pandemic prevented many Canadians from going on overseas vacations and since so many people are still working from home, it shouldn't come as a surprise to discover there has been a boom in cottage sales lately.
In fact, during the first nine months of 2020, cottage sales went up almost 12% in price, with some of Ontario surging in price by more than 70% since pre-Covid times.
Some of these cottages are now full-time residences because the buyers sold their previous homes to buy them. For others, cottages are a second home or getaway spot since the pandemic pretty much put a complete stop to international vacations. Canadians might not have considered the tax impact of these recreational property purchases.
Taxation and Selling a Cottage
There are three different tax treatments which can apply to Canadians selling real estate in Canada:
- Principal residence
- Business income
- Capital gain on investment income
Principal Residence
According to the exemption calculation for principal residences, the tax payable on the property sale is either eliminated or decreased. No tax is payable on the property sale if it was the principal residence for the whole time it was owned.
Business Income
Taxpayers engaging in the selling and purchasing of real estate as part of a business, whether dealing with one property or many, are usually earning business income on the property sale. That means the whole property sale price minus some specific expenses will be included as income, and in addition, taxpayers might have to charge the buyer for GST/HST fees.
Capital Gain on Investment Income
The property is assumed to have been bought as an investment, which is why capital gains must be paid. The figure will be the property sale price minus the adjusted cost base along with other sale-related expenses. Please note that you can have a negative number and therefore be considered a capital loss which will be used to offset other capital gains and you will have a result of less tax being owed
This applies to both personal and business properties but not principal residences.
Giving a Cottage to a Family Member as a Gift
If a family member receives your property as a gift or as an inheritance, it could trigger a capital loss or gain for you unless the property was your main residence.
If someone dies, all their capital property (apart from a principal residence) will incur a capital gain or loss. When all taxes have been paid, whoever legally represents the property should then apply to get a tax clearance certificate.
Exemption of Principal Residence
This exemption enables taxpayers to reduce how much tax is owed if a property is sold. A principal residence exemption is calculated as the number of years the property has been the taxpayer's main residence divided by how many years, they have owned it.
Someone spending some time in their cottage and some time in another residence means it's a little more complicated to work out the tax owed. If a property is 'ordinarily inhabited' by either the taxpayer or their spouse during which the exemption is claimed, then it's a principal residence. If you just visit a few times each year, then it's not.
Suppose a taxpayer owns at least two properties which could qualify as a principal residence, bear in mind they can only designate one as the main residence. In that case, they can choose which one they want to claim as their main residence, and it doesn't have to be the same property every year.
Usually, only 1¼ acres of property count as the 'principal residence,' and the rest will be taxable for capital gains. There are exceptions to this rule, so it's best to confirm with our tax accountants.
Change of Property Use
When you rent out a cottage you didn't rent out before or stop renting out one that you did in the past, this counts as a 'change of use,' and it will impact the taxes owed.
If the taxpayer starts to rent out their principal residence, then the exemption on principal residence offsets the tax.
If, on the other hand, a rental turn into a principal residence for the owner/taxpayer, they can delay paying any tax until the property is sold.
How about Foreign Recreational Properties or Foreign Buyers?
A Canadian tax resident can claim their principal residence as a foreign property if they live there. They might have to pay foreign taxes depending on where it is.
If it's not their principal residence and they have to pay foreign tax, the taxpayer might be able to claim some foreign tax credits in Canada.
Something else to bear in mind is Canada's tax treaties with other countries since this sometimes means the foreign country, rather than Canada, will tax the property sale.
A Canadian who owns foreign property valued at over $100,000 CAD must file a T1135 form annually, although personal use properties don't have to be reported on this form.
If a non-Canadian tax resident owns a cottage in Canada, any income earned by renting or selling it must be reported, and Canadian tax must be paid on it. If the home country in question has a tax treaty with Canada, this rule might vary.
International tax issues can be complex, and a lot can depend on whether the taxpayer lives in Canada and the property's location, which is why it's always best to consult our seasoned tax law team.
Denial of a Principal Residence Exemption
The Canada Revenue Agency, or CRA, is always trying to track down taxpayers who misuse the exemption because of the substantial tax savings that can be made.
If the CRA thinks a taxpayer isn't using the 'exemption for principal residences' correctly, they will argue that any income from the property sale should be taxed as a capital gain or, worse, a fully taxable business income. They also sometimes apply negligence penalties on top of the tax.
Sometimes the CRA makes mistakes when trying to identify taxpayers using the exemption on their principal residence, in which case, the taxpayers must be reassessed or audited to prove their case and show they have been living there.
It's a good idea for taxpayers to keep 'ordinary habitation' records, especially if they haven't lived at the property for much time. Acceptable evidence to prove residency can include government identification or utility bills with the property's address and the taxpayer's name.
Any taxpayer facing a tax reassessment or tax audit of their 'exemption on principal residence' should contact our Canadian tax accountants. They can assist in upholding your principal residence exemption claim.
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