Well, it’s that time of year again. As the days get shorter and summer winds down to a close, those who are fortunate enough (or crazy enough, depending on your viewpoint!) to own a cottage may begin to think about what to do with it for next year. Keep it? Rent it out? Sell it? Give it to a son or daughter?
Renting it out
Cottage rentals are usually short-term or seasonal, so the tax implications are slightly different than renting a house that you own to someone else. When you rent a property on a continuous basis, you must report the rental income, but you can deduct the expenses that you have that relate to that property – like mortgage interest, maintenance, property management fees, etc. (see complete list on Form T776).
The difference with cottage rentals is that often the owner will use the property for part of the year, rent it out for another part, and it will sit vacant for the weeks when nobody wants to be there. For that reason, expenses that relate to the cottage as a whole (like mortgage interest) will need to be pro-rated before they can be claimed. Expenses that relate specifically to the rental (like a listing fee on a web site) can be claimed in full.
Selling the property
Capital gains realized on the sale of your cottage are usually taxable, except in the rare circumstance when the cottage is the only property owned by either spouse for the entire time that the cottage has been owned. In this scenario, claiming the principal residence exemption on the sale of the cottage can wipe out any capital gains tax.
The more likely scenario is that a couple owns more than one property (i.e. a house and a cottage) and time is spent at both. The sale of one of these properties is going to be taxable. The usual logic is to figure out which property has the highest gain and use the principal residence exemption for that one, so you can pay tax on the lower gain. You don’t have to decide where to use the exemption until you sell one of the properties.
Long periods of ownership
If you have owned the cottage since before 1994, you may have filed an election that year that you’ve completely forgotten about. 1994 was the year that the $100,000 capital gains exemption (CGE) was eliminated. Transitional provisions were introduced to allow taxpayers to elect to essentially bump up the cost base of their property to use the CGE before it was gone. You may or may not have done this, depending on whether it worked in your favour at the time. Find your 1994 accountant and ask them to pull the records for you. Please don’t do this the day before the deadline – chances are they will need to retrieve records from storage. CRA may or may not have this information available on the My Account system.
There are other important dates you will want to discuss with your accountant if you’ve owned your cottage for even longer. Before 1982, each individual could designate one principal residence. So, if you owned your house and your spouse owned the cottage, the gain on both properties could be exempt up until 1981. In 1982, the rule was changed to one per couple instead of one per individual. If you’ve owned your cottage since before 1982, you may be able to have the gain up to 1982 be exempt. Speak to your accountant about this.
Before 1972, capital gains were not taxed in Canada at all. Knowing (or reasonably estimating) what your cottage was worth on December 31, 1971 could reduce your tax bill if the 1982 discussion in the previous paragraph does not apply.
Needless to say, calculating your capital gain when you’ve owned the cottage for a long time is not an easy task. Other issues to consider are improvements that you’ve made to the property and the restrictions on the amount of land that you can claim for principal residence exemption purposes. Getting professional advice in this scenario could save you thousands of dollars.
Giving the cottage to a family member
A new client once came to me with a reassessment for many thousands of dollars in tax. She had sold her cottage to her son for $1 for estate planning purposes. If she had been a client when the transaction was contemplated, I would have told her this was a bad idea on so many levels. I can’t remember what she actually paid for the cottage, but let’s say it was $100,000 in the late 1990’s. The value of the cottage had doubled (to $200,000) by the time she sold it so her son. She had not reported the gain on her return because she “sold” it for $1. Canada Revenue Agency reassessed the transaction to a $100,000 gain – representing the amount it was worth at the time of the transfer less the amount she paid for it. Not only did she not have the cash to pay the related $15,000 in tax, the gain also impacted her Old Age Security payments because it increased her income. A terrible mess! To make it even worse, when the son eventually sells the cottage (let’s say for $300,000), his cost base will only be the $1 he actually paid, so his capital gain will be $299,999. Don’t let this happen to you – get professional advice from both a lawyer and an accountant if you are contemplating any type of transfer to a family member.
Cottage rentals are usually subject to GST/HST due to their short-term nature. However, you may be eligible for small supplier status and therefore not be required to charge GST/HST if your rental and other GST/HST taxable revenue is less than $30,000. Talk to your accountant about this to be sure.
If you are a GST/HST registrant, it can cause further headaches when you eventually want to sell the property. You may be required to charge GST/HST on the sale price, increasing a potential purchaser’s cost by 5-15% depending on the province/territory. If the market can’t absorb that increase, you may have to reduce your price accordingly.
Collins Barrow (who I have no association with) published a great (yet very technical) article on GST/HST and your vacation home if you’d like to dig deeper into the details.
Perhaps all this tax talk is inspiring you to keep your cottage for another year (or more). If that’s your decision, then the good news is that you don’t have anything to worry about right away. If you find yourself with nothing to do on a rainy day this fall, you may want to consider digging up old records from 1994, 1982 and/or 1971 to get ahead of the game. Or you could just take a nap. Your choice!