Q: My mother leases an apartment in a retirement community, but also has a cottage. Can she declare the cottage as her principal residence? How can she avoid or minimize the taxes on the sale of the cottage to her children?—Fredlut2
A: Every Canadian can have one principal residence for tax purposes. It doesn’t have to be your home. It can be your cottage. If you only have one property, selling it generally has no tax implications. Your mother owns a cottage, like many Canadians, so the result is that there are likely capital gains tax to pay in the future.
In your case, Fred, you’ll need to look into the past to get your answer. If your mother had a home that she owned previously, it is likely that when she sold it, she didn’t report a capital gain or pay income tax on that sale. If that’s the case, if we assume she sold it in, say, 2010, the cottage will qualify as her principal residence for subsequent years, but not prior.
If she bought the cottage in, say, 1990 and she sells it in 2014, she will have owned it for 25 years upon the sale. But for only 5 of those years (2010-2014 inclusive) will it be her principal residence and qualify for a tax exemption.
If she has a $100,000 gain based on the original purchase price, 20/25ths or 80% would therefore be taxable to her.
If she owned the property prior to 1995, you should see if she made an election up to and including 1994 to increase the cost base of the property by way of the $100,000 lifetime capital gains exemption that used apply for Canadians.
If she owned the property prior to 1982, the property may be exempt from tax prior to that point because she and your father were both allowed to designate one property each as their principal residences.
And if she owned the property prior to 1972, the capital gain prior is tax-exempt as capital gains taxes weren’t payable by Canadians until that time.
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Renovations or improvements made over the years may qualify as capital costs that can be added to her original purchase price and decrease the ultimate capital gain.
If she’s going to sell the cottage to her children, the property needs to be sold at fair market value. In other words, you can’t choose an arbitrarily low value to reduce the capital gains tax.
You and your siblings might consider buying the property from her over a period of 5 years if the capital gain is quite large, depending on her tax situation and need for the sale proceeds. This way, as little as 1/5 of the capital gain would be taxable to her in each year over 5 years due to a capital gains reserve.
No matter what you do, Mom is going to pay tax on the cottage eventually. Whether she sells it to you kids or is deemed to sell it when she dies, in her case, a taxable cottage capital gain is as inevitable as death and taxes.
Sometimes, when it comes to cottages, I find people get carried away with avoiding or reducing capital gains tax or probate fees, but end up incurring significant and unforeseen costs. So I think tax should be just one of your concerns here, Fred.
If your mom genuinely wants to sell the cottage to you and your siblings and you all want to buy it, that’s one thing. But if you’re doing so just to get it out of her name and stop the capital gains tax clock, you should take into account other considerations.
In particular, your mother would give up ownership and exclusive use of the property on the sale. Is that what she wants?
How will you guys decide who uses the property and when? Shifting ownership of the property from Mom to you guys directly could create a sense of entitlement that makes battles for prime weekends more intense. Make sure you set ground rules ahead of time with your siblings.
Who will pay for the property? Presumably, Mom has been paying property taxes, utilities, insurance and repairs up to this point. If you kids buy the cottage, make sure you have a game plan and that you all agree on how the costs are going to be divvied in advance.
And while death, taxes and cottage capital gains are all inevitable, keep in mind the fact that divorce is about 50% inevitable right now in this country. If you guys buy the cottage from your mother now and you use it with your families, for marital and family law purposes, your share of that property becomes family property that may be divisible with your spouse in the event of a divorce.
So just remember, your mom may be able to avoid or reduce the capital gains tax on the eventual sale of the cottage with the principal residence exemption, but there are other potential costs of selling the cottage to you that need to be considered before a sale occurs.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products.