capital gains

Owning a cottage comes with extra responsibilities, particularly come tax time. Though more than 155,000 workers at the Canada Revenue Agency and the Treasury Board voted to strike late on April 18th, you still need to file your taxes before the April 30, 2023 deadline to avoid paying penalties.

You might be wondering if there are any special considerations you should be aware of before filing. A good CPA will always guide you in the right direction, but if you’re still handling your taxes yourself, or curious about the tax implications of buying a cottage—here are a few tax considerations you’ll want to keep in mind.

The Staycation Tax Credit

The Staycation Tax Credit was first introduced by the Ontario government in 2021 as a way to bolster travel within the province when out-of-country travel was still challenging due to the pandemic. It was also introduced with the intention of helping Ontario businesses bring in new income as the travel and hospitality industry suffered a huge hit during periods of lockdown.

So, if you live in Ontario and you rented a cottage in Ontario in 2022, you can claim the rental fee you paid and receive a tax credit. “The credit applies mainly to lodging—you can’t claim it on flights, gas, or admission to different parks and amenities,” says Jeanette Chong, a CPA at Canadian Bookkeeping Services. The credit amounts up to $200 for an individual and $400 for a family. “You may need to provide proof, so always keep your receipts for at least seven years,” Chong says. “Since it is a refundable tax credit, you will get this credit regardless if you owe taxes in 2022 or not.”

Claiming rental expenses

If you rent out your cottage even for a short portion of the year, don’t forget to claim rental expenses on your taxes. “You can claim expenses such as property taxes, maintenance fees, and mortgage interest,” Chong says. But keep in mind that you must accurately report expenses based on the time your property was used as a rental. That means, if it was only rented out for two months of the year, you can only claim these expenses for 17 per cent of the year. “In this case, you can claim 17 per cent of property taxes, mortgage interest, and maintenance fees for the year,” she says.

When it comes to expenses related directly to renting the property, you can claim 100 per cent of these expenses. “For example, if you have a cleaning service come in after each renter to clean up, or place an ad somewhere to rent it out, then 100 per cent of those expenses can be claimed.”

Deferring capital gains

Keeping the cottage in the family over generations is a goal for most cottage owners—but that’s not as simple as it seems. When it comes to second homes like cottages, capital gains can become an expense that many children taking over the cottage from deceased parents aren’t prepared for. Especially with cottages that were bought decades ago for a small fraction of what they’re worth today. “When you pass on your cottage, the difference between what you paid for it, and what you sold it for is considered a capital gain,” Chong says. Since your children are on the hook for the capital gains tax upon your death, this bill can come as a big shock. If a cottage was bought for $70,000, for example, and is now worth in the millions, that capital gains tax bill will be large.

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But there are ways to ease this tax burden—if your cottage is now worth more than your principal residence, you can switch the cottage to your primary residence for tax purposes and have the second home capital gains tax applied to your other home instead. Alternatively, you can consider co-owning the cottage with your children now. This would require capital gains tax payment on the portion your children now own, making the portion they have to pay after your death significantly less. You can even gift it to them now in full, paying the capital gains tax up until now, so the burden is lessened for them. Of course, there is always a risk in giving up ownership of property, especially if your children have creditors, or spouses who might have other plans for it—so consider these options wisely.

“Another scenario where you can defer the capital gains is if you use that money from the sale to purchase another property,” says Chong. “In the end though, you will still have to pay the capital gains when the second property is sold.”

Expenses you can claim after selling

Finally, if you sold your cottage, don’t forget to claim expenses. “If it is not your principal residence, there are things you can claim—including the cost difference from the original purchase price of the property, land transfer taxes, real estate commissions, real estate inspections, legal fees, and renovation costs,” Chong says. A tax specialist can help ensure you’re claiming everything you legally can, so your tax responsibility will be as low as possible.

My brother and I were given title to the family cottage as an early inheritance from our elderly father in 2020. The cottage was built in 1990. Our father chose to designate it as his principal residence as of 1994 and paid the capital gains for the period between 1990 and 1994 in his 2020 tax return. If and when my brother and I ever choose to sell the cottage, which had an MPAC assessed value of $550,000 in 2020, would the starting value for the capital gain be based on that $550,000 amount, or on the 1994 value of $135,000 that our father used in his 2020 tax return?—Harry V., Catchacoma Lake, Ont.

Neither value. The starting value for the tax calculation if and when you sell it will be the cottage’s “fair market value,” determined by the cottage’s sale price. That’s obviously not MPAC’s assessed value, and it’s not the historical FMV from 1994.

Getting an appraisal of the cottage’s value now if you don’t end up selling it for, say, five years, wouldn’t be useful. Market values are fluctuating, says Peter Lillico, a lawyer with Lillico Bazuk Galloway Halka in Peterborough, Ont. “The cost of the appraisal would just be money thrown away.”

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But it wouldn’t be a waste to calculate the cottage’s adjusted cost base now. (Math equation time! The adjusted cost base = the cost base, a.k.a. the value as of the date of purchase or inheritance + the value of the capital improvements since the date of purchase or inheritance.) To find this number, you’d get a historical appraisal to establish the cottage’s 2020 value—the cost base—and add the money you’ve spent on any capital improvements since acquiring the cottage—a new roof or an expanded dock, for example.

Then you and your brother “are loaded for bear,” says Lillico. The adjusted cost base is the amount you’d subtract from the sale price when you’re ready to sell in the future.

This article was originally published in the Sept./Oct. issue of Cottage Life.

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