Croot and Carey paid off their 25-year mortgage in 2002, 10 years earlier than expected. With the freed-up income, they were finally in a position to focus solely on building up their retirement savings—and that’s exactly what they did, continuing on with their regular jobs for three years prior to moving to Port Hope. These days, Phil is retired from his engineering career, while Heidi has transitioned to part-time work. Their only regret is that they didn’t figure out how to do this earlier.

As the couple will attest, paying off your mortgage is the single most important step towards financial independence and a prosperous retirement. Owning a principal residence outright gives you the financial freedom to funnel money that formerly went to your mortgage into your savings or to pursue lifelong dreams like travelling. Don’t forget, too, that mortgage interest adds tens of thousands of dollars to the real cost of a home, so a shorter mortgage slashes the amount you pay in total. Paying off your mortgage as quickly as possible should therefore be an important goal for any homeowner—whether you’re halfway through the process, just starting out, or even just contemplating buying a house.

If all the above advantages sound compelling, bear in mind that sacrifices will have to be made. “Paying off the mortgage early wasn’t easy,” Croot says. “We had friends who were going out twice a week for dinner and we didn’t do that.” Without question, tightening up your spending is a key tactic for freeing yourself from mortgage debt, but there are also many other strategies that won’t cost you a dime and can save you thousands. Allow us to let you in on the secrets every prospective and current home owner should know.

Polish off your credit score

If you’ve always paid off your debt in a timely manner, your credit score should be fine. But that doesn’t mean you couldn’t have any unexpected surprises, says Toronto fee-only adviser Jason Heath. He cites the example of a client who was buying a condo and was unaware she had $300 outstanding on a Holt Renfrew card. It took her more than three months to repair her credit rating. While that single infraction wouldn’t have been enough for a bank to deny her a mortgage, it could have resulted in a significant jump in her interest rate.

Moshe Milevsky, an author and finance professor at the Schulich School of Business, says people applying for mortgages should pull their credit scores six to 12 months in advance to make sure there’s nothing wrong. “Get your credit report from all the bureaus,” he advises. Also, try to avoid job volatility for at least six months before applying, as this will make your income appear more stable in the eyes of the banks.

Maximize your down payment

While all home mortgages in Canada require a minimum 5% down payment, paying 20% upfront is one of the single biggest cost-cutting measures a borrower can make. Not only will you owe the bank less principal and interest, but critically you will avoid having to pay Canada Mortgage and Housing Corporation (CMHC) insurance premiums that would add thousands of dollars to your mortgage. CMHC mortgage loan insurance doesn’t protect you—it protects your bank if you default. It’s mandatory in Canada for down payments from 5% to 19.99%. (This insurance can also be purchased through Genworth, a private company.) And the cost is substantial—for instance, if you only put a 5% down payment on a $350,000 home, the CMHC premium will be a hefty $9,144.

If you can’t afford an initial payment of 20%, putting down 10% to 15% will still reap major financial savings. “Those are the insurer breakpoints where insurance fees drop,” says Vancouver mortgage broker Rob McLister. “For example, putting down 10% instead of 9.9% saves you 0.75 percentage points off your entire mortgage amount. That’s $1,500 on a $200,000 mortgage.” For those looking to boost their down payments, the Home Buyers’ Plan is a popular option; it lets you withdraw up to $25,000 in a calendar year from an RRSP to put toward a home you are buying (or building).

One of the best strategies for avoiding mortgage default insurance premiums—and to get into the market sooner—is to buy a house that fits your budget. “Sometimes you can’t move into your dream house as quickly as you want,” says Jason Heath. “But with a smaller property you’re that much closer to having that 20% down payment, not to mention money left over.” That was the strategy Anne Langevin, a 43-year-old retail clerk, and her husband Rene, a 42-year-old finance manager, followed back in 1998 when they bought a $210,000 suburban starter home in Mississauga, Ont. “It was just the two of us and the house was reasonable. It wasn’t a huge mansion,” says Anne.

Get the best rate

Prospective home buyers often stick with their own financial institutions when applying for mortgages, but it pays to shop around. Credit unions and non-direct lenders, known as monolenders, will offer a discount—sometimes just a fraction of a percentage point—that will save you money on interest payments compared to larger lenders. For those worried about getting mortgages from more obscure companies, Heath says to remember you’re borrowing, not investing. “The fact it’s a more obscure institution makes it no riskier than a bank. You’ve already got the money.”

Heath recommends scanning the major rate comparison websites—such as Ratesupermarket.ca or Ratehub.ca—to get a general sense of where the market is. Also be sure to ask your lending institution if the interest on your mortgage will be compounded monthly or semi-annually. The less often the interest is compounded the better—semi-annual compounding could save you hundreds of dollars or more in interest.

If you’re not comfortable negotiating on your own, a mortgage broker will do that on your behalf for free. Mortgage brokers are paid a finder’s fee by the lender. There’s no charge for a pre-approval and no obligation. “We’ve always used mortgage brokers,” says Anne Langevin. “When you go into a bank you have to haggle for a lower rate. My husband and I don’t like to haggle.”

Normally variable-rate mortgages are a better deal than fixed-rate mortgages because you pay a premium for the security of locking into a rate. However, that doesn’t appear to be the case right now, says Jason Heath. “Fixed and variable rates have almost been identical for five years—2.9% on fixed and 2.8% on variable,” he says. “So, arguably the cost of locking into a fixed-rate mortgage is so cheap that it’s more compelling to do so.”

Watch the fine print

Securing a low interest rate can shave years off a mortgage, but equally important are the terms of your contract. “Not looking into that and just going by the rate can get you into trouble,” says Calgary mortgage broker Joe Jacobs. For instance, when the Bank of Montreal was the first major lender to drop its five-year lending rate to 2.99% early in 2012, you couldn’t break the mortgage to switch to another lender. “That’s a fairly significant thing,” says Jacobs, “but a lot of clients didn’t know what that was.”

This is where experienced mortgage brokers can make a difference, he says. They will review any restrictions or potential penalties on the mortgage that may end up costing you far more than a small rate difference.

Prepayment privileges also go a long way toward helping pay off a mortgage faster. It may seem unfair, but most mortgages limit your ability to pay off your debt early because the financial institutions will lose the interest revenue that they were expecting. Most mortgages allow borrowers to make annual prepayments of 10% to 20% of principal, without extra fees, with the increased payment amount going directly towards the principal. Just be sure to inquire about the details, as some “no frills” mortgages may prohibit this option. Also be aware that payout penalties—the fees you’ll pay if you break your mortgage early—can sometimes cost tens of thousands of dollars.

The right amortization

Those who want to pay off their mortgages sooner should choose the shortest possible amortization within their financial means, or, as Moshe Milevsky, puts its: “as short as possible until it hurts.” While the typical amortization period is 25 years, it can be as short as 15 years, or as long as 35 years (if you made a down payment of 20% or more on your home). Forcing yourself to pay off the mortgage in fewer years translates into lower interest costs and substantial savings. The major hitch, however, is that your regular payments will be much higher.

To give yourself the best of both worlds, Vancouver mortgage broker Mark Fidgett advises going with a longer amortization, but setting your regular payments higher with prepayment privileges. In effect, you could be paying off a 20-year mortgage in 10 years, but you’d also have the flexibility to switch back to smaller installments if you were to experience any changes like a job loss or the birth of a child. “That way, you’re in control,” says Fidgett. Your payment schedule can also make a big difference. Payments can be made every month, twice a month, every two weeks or weekly. Going with one of the latter two options is preferable because it will accelerate your payments by an additional two weeks every year. For instance, over a 25-year amortization period on a $350,000 home with a 3% rate you would save more than $18,000 in interest by going with an accelerated biweekly plan.

Prioritize your mortgage

Maximizing your down payment and procuring the best rate and terms possible will save you thousands of dollars. But extra payments will have the biggest impact. To do that, you’ll have to make some tough decisions about your spending and cut out non-essential items, such as family vacations and other luxuries. You may need to stop saving for retirement, depending how serious you are about being free of your mortgage. While that may seem extreme, those who free up their home debt quickly can easily make up for lost investment time later on, provided they funnel cash that previously went to their mortgage into retirement savings.

Remember that paying off debt has the same impact as saving, as both add to your net worth. However, most people’s retirement money is in investments that may or may not gain value, while money paid against the mortgage gives you a guaranteed return by saving you interest.

Nicholas Hui, an auto parts salesman, and his wife Kathy Chan, a law firm marketing manager, followed this strategy, paying off their $434,000 mortgage on their Markham, Ont. home in six years. “We didn’t have extravagant lifestyles,” he says. “We didn’t go to Europe or anything.” Instead, they opted for an open mortgage, which has a higher interest rate but no penalty for making extra payments. Several years of sacrifice and a few $20,000 and $30,000 lump-sum payments helped them meet their goal. These days, they’re quickly catching up on their RRSPs and have started RESPs for their young children—all without the burden of a large mortgage hanging over their heads.

The real key to paying off your home faster is to make sure you get a mortgage that allows you to make extra payments throughout the year and take advantage of them. “That’s the most likely way you’re going to pay off your mortgage a bit quicker,” says Heath. He says borrowers are less likely to make extra payments if they are only allowed to make a single lump-sum contribution on an anniversary date.

Another strategy for paying off your mortgage faster is to increase your regular payments to the maximum allowed without penalty, typically 10% to 15%. Some mortgage contracts also allow borrowers to double their payments. That was one of the strategies Anne and Rene Langevin used to pay off their $210,000 home in less than five years. In addition to making prepayments of 15% to 20% annually, says Anne, “we doubled-up payments whenever we could.”

Paying off your mortgage early isn’t easy, but you’ll thank yourself for it later on. Back in Port Hope, Heidi Croot and Phil Carey are living proof. These days, the couple enjoy living debt-free in their country home, which sits on seven acres of lush property in Ontario’s Northumberland County Forest. Although the two have socked away a nice chunk of money for retirement, Croot still enjoys working part-time to earn additional income—but at a far more relaxed pace. Budget vacations have long since been done away with, too. “We take more expensive ones now,” says Croot. “Africa is on the horizon. We did Maui last November.” All the sacrifices the couple made years ago to free themselves of mortgage debt have paid off. As Croot puts it, “It’s good to be alive and in the driver’s seat.”

The couple, who were only in their late 20s at the time, were establishing good careers for themselves and decent money was starting to come in. “The plan was to be as aggressive as possible to pay off the mortgage in 10 years,” says Levett. They succeeded, paying it off in just six years.

Levett and Elman did it by spending every dollar carefully. “We didn’t go on any extravagant trips or buy expensive cars,” says Levett. “One hundred per cent of the tax refund went to the mortgage.”

One of their biggest motivations was that they wanted to do renovations but had agreed to wait until their debt was paid off, says Levett. “The first one we did after paying off our mortgage was digging out and extending the length of our basement. And after a few years we gutted our kitchen.”

Want to pay off your mortgage early too? Read “Crush your mortgage” for tips on how to get a head start.

Such good habits served the couple well when they received cash gifts the year they were married. “We kept the money. We didn’t blow it,” says Anne. Along with those funds, and other money they had diligently saved, the Langevins—who now live in Oakville, Ont.—were able to put a $70,000 down payment on a $210,000 Toronto-area home back in 1998.

Before the purchase, while the couple was still living in an apartment, they never bought anything that wouldn’t be appropriate for a full-sized home. “Everything we purchased was always intended for a house,” says Anne.

They also bought only new items for their house with cash. “When we first moved in, we took turns sitting on the floor for six weeks because we had only one La-Z-Boy recliner. Then when we’d saved enough money, we bought a couch. We weren’t killing ourselves with credit-card bills.”

Want to pay off your mortgage early too? Read “Crush your mortgage” for tips on how to get a head start.

As fervent Toronto Raptors fans, they hatched a plan that allowed them to satisfy their itch for live basketball for free. They would purchase season tickets, which can provide up to 37% savings over regular game ticket prices, pick the games they wanted to attend on weekends, and then sell the remaining tickets at face value to break even. “It’s perfectly legal,” Nicholas points out.

The couple was also shrewd when it came to vacations. While European getaways were not within their budget, the Vancouver natives would go home annually, combining some downtime with family visits. And, of course, Nicholas says, staying with Mom and Dad is always free.

The couple’s main reason for paying off their home early was financial flexibility. As the parents of three young children, the couple wanted to start saving for their future schooling costs.

Want to pay off your mortgage early too? Read “Crush your mortgage” for tips on how to get a head start.

Rui Torrao’s 10% cap rate target is very difficult to find these days: a recent analysis by Boardwalk REIT found cap rates for high-quality large apartment buildings ranged from 3.75% to 4.75% in Vancouver and 5.75% to 6.75% in southwest Ontario. In this hypothetical example, we’ve assumed you put 50% down on a property valued at $300,000. We’ve also assumed the mortgage interest rate is 3.5%, amortized over 25 years.

Often, it’s these encounters—followed by less than desirable vacation experiences— that give timeshare ownership such a horrible reputation. But the reputation is unwarranted. In fact, a timeshare can be an excellent budget option for vacations, as long as you do your homework.

“Nothing matches the value of a timeshare,” says DG Southen, an experienced real estate investor from London, Ont. For the last decade Southen has bought, sold and used timeshares. Southen, and thousands like him, has found ways to make timeshares work as cost effective vacation options.

In the current issue of MoneySense magazine (“Own A Piece of Paradise,” June 2013), I touch on the effective use of timeshares, but I want to expand on my coverage. Partly because timeshares are a misrepresented vacation option, and partly to help those interested in purchasing timeshares to make more informed decisions.

What, exactly, is a timeshare?

The idea behind a timeshare is relatively simple. It’s an agreement where you share the costs and use of a home, cabin or condo with other people. When you buy a timeshare you are buying the right to use these shared facilities and paying the costs for such rights.

Unlike hotel rooms, and much like resorts, timeshare units offer more than just a place to sleep. Typically they come with full kitchens, are completely furnished, have quick access to indoor and outdoor pools, as well as other resort amenities, such as restaurants, night clubs and even babysitting services.

How do timeshares work?

There are three basic types of timeshares: right-to-use, fee simple, and a point system or vacation club timeshare. The rules are different for each one—and this can dramatically impact the price and resale value of the timeshare (along with other factors that I’ll get into later).

Right-to-use timeshares are contracts to lease a property, usually for one or two weeks each year, over a set period of time. During this time you are responsible for all maintenance fees and any special assessment fees, should they arise. (Like a condo, timeshare resorts must maintain a property. At times significant repairs are required and to pay for these repairs, the resort will levy a one-time special assessment fee that is shared by all owners of the timeshare resort.) At any time you can rent, give away, or sell your right-to-use ownership of the timeshare.

A fee-simple timeshare, also known as a deeded timeshare, is essentially like buying the property for a specific period of time each year. You will be responsible for the purchase price, as well as annual maintenance fees or special assessment fees, should they arise. You may also need to pay property taxes or other fees although many timeshares now roll these costs into their annual maintenance fees.

Timeshare point systems or vacation clubs allows you to buy points within a resort network. You can then use these points to “purchase” the vacations available within the specific network. The benefit of a point system is that it doesn’t lock you in to a specific property and time each year. Instead these points give you access to multiple properties worldwide and some even allow you to purchase flights, cruises or other types of vacations offered within the system.

What will my timeshare actually cost (resale vs. retail)?

According to industry statistics, 50% to 70% of a timeshare’s retail price—the price you pay at the resort after listening to a timeshare sales presentation—goes towards marketing. For instance, if, during one of those presentations, you purchased a timeshare for $20,000 as soon as you walked out of the room, the value of that timeshare would drop to between $6,000 and $10,000, if that.

The easiest way to save money, then, is to buy resale not retail. This is how Southen has kept his vacation costs down and his timeshare value up. There are a number of websites that offer resale timeshares, such as Ebay, Tug2.net and Redweek.com.

Next, you’ll need to calculate one-time costs and ongoing fees associated with timeshare ownership. For instance, just to finish the transfer transaction you’ll pay between $300 and $500 in closing legal costs, plus another $50 to $300 to the resort. Factor in the annual maintenance fee—fees that cover the operation of the timeshare resort—fees you must pay even if you don’t end up using your timeshare. These fees range from $300 to $2,000 (or more) per year depending on the resort, destination and luxury level you’ve bought into.

You should also be aware of special assessments. Southen went through this with a timeshare he owned in Whistler, B.C. The resort required additional structural repairs and, like a condo, each timeshare owner had to foot the bill. Southen got off lucky. He, and all the other owners, only had to pay $1,000 each to cover the repairs, but it could’ve been worse. To avoid these unexpected costs call the resort property manager and ask when the last assessment took place and when the next one is scheduled to take place. If the resort waits too long between assessments—more than five years—then, you as an owner, may end up with a hefty one-time maintenance bill.

Where do I start my research?

Start with a pen and paper and make a list of all the amenities and destinations that would suit your family best, along with your ideal times for taking these vacations.
Then start checking the online auctions to see what prices your ideal choices are selling for in the current resale marketplace. “Don’t bid on anything, just watch,” advises Southen. “You won’t miss anything, because there’s always another good deal.”

At this time also watch and learn how specific auction sites work. For instance, sellers on Ebay can choose to end an auction early, and sell to the highest bidder, once they’ve achieved a set bid price. Other auction sites won’t allow “snipe” bids—bids made in the last minute or so. For instance, Redweek.com will add another 30 minutes to the clock for every “snipe” bid made within the last 10 minutes of the auction.

As you research you may find that some of your top choices are just too expensive for your budget. For example, a two-bedroom, ocean front villa in Myrtle Beach you have your eye on will start at $14,000. Despite the sticker price, any veteran timeshare owner will tell you this is an excellent deal—it’s a vacation area that’s always in demand and retains its value. But it may be a bit pricey for the budget conscious vacationer. Instead, you could pick up a great two-bedroom at the Sheraton Desert Oasis in Scottsdale, Arizona (which recently sold on Ebay for US$2,000), or a two-bedroom, ocean front, every-other-year timeshare at the Pahio Kauai Beach Villas in Hawaii (which recently sold on Ebay for US$1,300).

The key to getting a good deal is to watch the auctions, learn the system, and do your homework, says Southen. Then match what you’ve learned with what your family needs and wants and you won’t end up overpaying.

Part 2: Get to know the lingo

It helps to understand how the system works. Generally, if your assessment value goes up by less than your municipality’s average, you won’t face a tax increase; if your home value rises more than is typical, it could lead to higher taxes. It can also hurt your resale value if you’re paying more than neighbours who are living in similar homes.

If you suspect your assessment is too high, contact your municipality’s assessment corporation. Often there’s a straightforward way to appeal, but keep in mind there are deadlines you need to hit. The key to winning is to find other properties like yours that sold at the time of the assessment date for less than your assessed value. You’ll also want to point out things that make your house less desirable, such as proximity to a railroad or major street.—Sean Cooper

According to my accountant, this isn’t necessarily a problem. His rationale: If you owe tax it means you’ve made money. And capital gains are taxed at only half your marginal tax rate—one of the more favourable tax treatments offered by the CRA.

The real quandary, for most readers, is how to calculate this capital gains tax when the sale of the property is a tad more complicated than selling your principal home.

For that reason, I address some of the more interesting questions readers have sent regarding the sale of property and how to calculate the taxes owed on their capital gains.

(For more on the basics of the principal residence exemption and how the sale of property doesn’t always produce a capital gain see my Home Owner column in the June 2013 issue of MoneySense on newsstands May 13.)

Claiming investment expenses

Recently a reader, who had bought and rented out a condo as an investment, asked if he could claim the condo’s special assessment bill as an expense against the potential capital gains tax he’d owe once he sold the condo.

“He’s mixing apples with oranges,” says Albert Luk, lawyer with Devry Frank LLP, a Toronto-based law firm. You can’t claim business expenses against a capital gain—you can only claim deductions against business income (or annual expenses against annual rental income). If you want to reduce your capital gain you need a capital loss—such as selling stock that dropped in value.

Every investor has to make a decision, says Luk, either claim expenses and report the sale as income, or eat the expenses and sell the property as an investment, enabling it to qualify for the preferential capital gains tax treatment.

I won a home!

For the fortunate few, lottery wins are not taxable. That’s great news for one reader who wrote in asking how to calculate the capital gains tax on the sale of a home they won in a regional lottery.

“If you don’t already own a principal residence, the home can be sheltered from taxable gains through the principal residence exemption,” explains Scott Plaskett, president of IRONSHIELD Financial Planning, a fee-only firm in Toronto’s west-end.

If you already own a home, and decide to sell your winnings, the CRA will calculate your capital gains based on the difference in current market value of when you won the home versus when you sold the home. The longer you wait, the greater chance you’ll owe capital gains tax.

“I had a client who won a home in the Princess Margaret lottery,” says Plaskett. The client already had a principal residence and, though appreciative, wanted to sell the winning home quickly. The client sold and paid no tax, as the capital gain was almost nil from when he won to when he sold. “He was just tired of cutting the lawn.”

Renting out your basement

Many readers want to know if their home will continue to qualify for the principal residence exemption if they rent out a portion of their house. Their concern is prompted by stories of people who lost this exemption after years of renting out their basement.

While it’s true—you can lose your principal residence exemption—it really only happens if you rent out more than 50% of your home, or when you decide to claim capital cost allowance on the portion of your home that is the rental.

The CRA recognizes that, over time, depreciable property will become obsolete. Believe it or not, this also applies to real estate. Because of this you are well within your right to offset this loss in value by deducting the depreciation over a period of several years. This deduction is the capital cost allowance (CCA). However, if you claim CCA on your home, you are effectively telling the taxman that this property is used to produce income, and you use lose the opportunity to claim a capital gain, which is taxed much more favourably than income.

But what if you buy a duplex or fourplex and live in one unit while renting out the others? Can you deduct costs, including CCA, to offset the rental income you collect each year and still claim a principal residence exemption? Yes: but you’ll need to clearly document what portion is for personal use and what portion is rental. Only deduct expenses for the rental portion. When you sell, you can claim the principal residence exemption for the portion that was for personal use. To understand how this all works, consider the following:

• Buy a duplex for $400,000.
• Rent out one unit (for $1,500 per month) and live in another.
• Each year you report your annual rental income (about $18,000) and then offset these earnings with expenses associated with the unit. Remember: you cannot deduct expenses, including CCA, for the personal portion of the duplex.
• After four years you sell the duplex for $500,000.
• Because 50% of the property is used for personal use, you can shelter 50% of the $100,000 capital gain.

But be forewarned: CRA is cracking down on income generated from real estate, and in order to qualify for the principal residence exemption no more than 50% of a principal home can be used for rental purposes. For people thinking of buying and investing homes with a personal use portion you may want to seek out professional advice.

Gifting property (and avoiding probate)

In Canada, you can give gifts to loved ones without tax implications (at least for the recipient). However, this doesn’t mean you can completely avoid taxes when you gift money, stocks, shares or property. “There are tax implications on gifted property as the CRA sees this as a transfer of ownership, which is a deemed disposition,” explains Plaskett.

Still, many parents consider gifting property either upon death or before (by adding adult children to the title) as a great way to transfer property and avoid probate and other taxes.

“Because Canada doesn’t have a gift tax, like the U.S., people often get caught in tax traps when they start gifting without knowing the implications,” explains Luk.

If a parent gifts an adult-child real estate, the CRA considers this transfer of ownership as a disposition: a virtual sale of the property at fair market value. As a result the parent will owe taxes on any appreciable gain on the property (from when they bought the property to when they gifted the property). The parent can avoid these taxes if the gifted property qualifies for the principal residence exemption.

However, the adult-child will have to pay capital gains tax on the property should they decide to sell (and if they already own their own principal residence). The quicker one sells, however, the lower the chances of a capital gain, and the lower the chances of taxes owed. That’s because the capital gain is only calculated from the point of inheritance to the point of disposition. Add your adult-child to title years before you die and you’ll simply be increasing the potential for a capital gain and for taxes owed on that gain.

“It gets even more complicated if you gift property to a spouse or a related minor child,” says Luk, where the gifter may be hit with “an unexpected tax consequence known as the attribution rule.” This is when income, dividends and capital gains are attributed back to the gifter. “The take-away is that not all gifts can be given tax-free, even if there is no gift tax, per se.”

Sever land

Another option some readers have considered is to sever their land and to build two houses—keeping one home as their primary residence and gifting the other house to either a family member or the builder.

“This is a tricky timing issue,” says Plaskett. Anytime there is a change of use in a property the CRA considers this a deemed disposition. If the land originally housed their principal residence, then the gifters are sheltered from capital gains tax. However, the recipient—whether it’s a family member or the builder—would be subject to capital gains taxes if they built and then sold the additional home. That means if a builder built the two homes for $1.1 million, and then took possession of one and sold it for $750,000, the builder would owe tax on the $200,000 capital gain. Worse: because of the builder’s profession, this gain could actually be considered business income by the CRA, which eliminates the capital gain tax treatment on the sale of the house and forces the builder to pay his full marginal rate on the $200,000 profit.

If, however, the recipient chose to keep and inhabit the home as their primary residence, this would “make it a tax-free transaction,” says Plaskett.

Anyone interested in pursuing this type of gift should talk to a professional, as the CRA may have different rules depending on whether you sever the land before or after you build the two homes.

One building, two uses (business and residential units)

Those interested in diversifying their type of real property holdings may have considered (or already bought) a mixed residential/commercial unit. But when it comes time to sell there can be some confusion on how the capital gains tax will be applied.

“Whenever you have a mixed usage property you want to keep meticulous records,” says Plaskett. “Particularly regarding the value of the building or each unit during times of usage change.”

This will require owner to pay for an assessment or ask a realtor to provide a market comparison analysis and an evaluation of the fair market value of the building at each stage, says Plaskett.

By valuing each unit during each phase of use, you can determine your adjusted cost base (ACB)—a tax term that refers to the change in an asset’s book value.

For example, say you buy a home for $250,000 and live in it for five years before deciding to buy a larger property and keeping your initial home as a rental property.

Since you’ve changed the use of the initial house you are subject to capital gains taxes, but since it was your primary residence you can claim the exemption. This won’t work, though, when you go to sell this property a few years later. The good news: You can reduce the taxes owed by determining your ACB for the property.

By obtaining a valuation of the property at the time it stopped being your primary residence, you can shelter those capital gains from future tax repercussions. Here’s how it works:

• Buy a home for $250,000 and live in it for five years.
• Transition the home from residence to rental property.
• At that time, obtain a fair market value report (either from an appraiser or a Realtor) that values your home at $350,000.
• Sell the rental property three years later for $400,000.
• You will only owe tax only on $50,000, as the additional $100,000 gain is sheltered using the principal residence exemption.

Now, it doesn’t matter if the property is separated into different residential units, or commercial and residential units, the same principles apply.

Be forewarned: the ACB calculation can get a bit tricky. For instance:

• You buy a duplex for $750,000.
• You move into one unit and rent out the other.
• A few years later you move out of your unit and rent it out.
• At that time you obtain a fair market value report from a Realtor, which states that the property is currently worth $1 million.
• A year later you sell the duplex for $1.1 million.

In this example, only the $600,000 gain would be taxable at half your marginal rate, says Plaskett, as the principal residence portion of the building would be exempt.

Whether or not you made money can get even trickier if your ACB is lower than the current market value of the asset. “Always ask yourself: what did you take out of your jeans to invest,” says Plaskett. “And don’t forget: Anything you receive—whether it’s interest, rental income, or dividend—is part of your investment return.”

Tenants in common

When a married or common-law couple owns a home together the ownership is known as joint tenancy. This allows for the automatic transfer of the property to a surviving spouse without penalty or prior paperwork. (As with anything, this arrangement gets more complicated when you have a mixed or blended family.)

Yet, when adult children inherit a property they become tenants in common. This type of ownership allows two or more people to have equal ownership interests in a property. Unlike joint tenants, however, each can choose the beneficiary that inherits their portion of the property, should they die.  Where appropriate, tenants in common may also choose to sell their portion of the property, without consent from the other owners. And tenants in common ownership is not limited to people who inherit property. Many investors also opt for this type of ownership when there are two or more investors in one property.

When it comes to calculating tax, though, each tenant in common is on their own. “Everyone has their own adjusted cost base,” says Plaskett.

For instance, if two adult children inherit a property with a fair market value of $1 million and then rent it out, their adjusted cost base would be $500,000 each. A year later, investor A sells his portion of the property to investor B for $750,000. When investor B sells the property for $2 million, she will only pay half her marginal tax rate on $750,000 of the profit, because her ACB is $1.25 million ($500,000 plus $750,000).

Inheriting international property

In Canada you’re required to report your worldwide income and assets. Any profit earned on the sale of the foreign property is calculated in the same manner as non-primary residence property sold in Canada.

“Even if you own or inherit a home in Florida that doesn’t mean you avoid taxes,” says Plaskett. But there are ways to avoid taxes on foreign property. “If you put the property into a trust, so you don’t personally own the property, then you don’t have to worry about the capital gains once you sell the property,” explains Plaskett. The trust will pay U.S. tax, but will be exempt from Canadian taxation. Get expert help if you’re thinking of setting up a trust, however, as tax treaties and legal methods of minimizing tax can get complicated.

Getting hitched

You’ve fallen in love and you want to move in together, but you both own your own homes, what should you do to minimize taxes?

“There are several options for a couple where each person owns their own principal residence but they want to move in together,” says Albert Luk, lawyers with Devry Frank LLP, a Toronto-based law firm.

The first option is to sell one of the homes. This person could claim the principal residence exemption and avoid paying capital gains taxes. But to qualify for a principal residence exemption you will have to sell the home before getting married (or moving in together). Under tax laws a family unit can designate only one property as their primary residence—and a family unit includes spouses and all dependent children.

The second option is to convert one home into an income producing property by renting it out. You will trigger capital gains taxes but only from the time you started renting out the property to the time you actually dispose of the property. That’s because the CRA considers the change in the use of the property as a deemed disposition—tax talk for a change in use of a property is the equivalent as a sale at the current, fair market value.

If you opt to keep the second home as an income property you can minimize the taxes owed by keeping good records. “Get an appraisal or a property valuation just before you change the use of the property,” says Scott Plaskett, president of IRONSHIELD Financial Planning, a fee-only firm in Toronto’s west-end. That way when you go to sell the home, the capital gains tax will be calculated from the time the home became a rental property, not from when you first purchased the house.

Getting divorced

A few readers ask what the process is for calculating capital gains tax on a home that was part of divorce proceedings.

If the divorce is short and sweet—and both parties have vacated the home in order to quickly sell the property—then taxes would only be owed from the time the home stopped being a primary residence for the couple until the time the property sold.

The longer it takes to sell the property the greater the chance for potentially higher capital gains taxes being owed. (The assumption being that the property will appreciate over time.)

If, however, one half of the couple continues to live in the property and chooses to buy out the other half, there will be no capital gains tax owed as the home is still being used as a primary residence.