Capital gains tax: Declaring the cottage ‘principal residence’

Almost all property is subject to capital gains tax

  6

by

Online only.

  6
A reader wants to know if turning their cottage into their home means paying capital gains tax? (Getty Images)

A family wants to know if turning their cottage into their home means paying capital gains tax? (Getty Images)

Q: We bought property 28 years ago which we used as a weekend getaway for 14 years. There were a few small buildings on the property, but no significant home on the lot. The largest building was a garage. We then sold our home and moved to this property fixing up the garage making it into a small cottage. In other words, this became our principle residence for the next 14 years and we continued to make improve to the home and the property. Now we’d like to sell it, but we’re not sure what capital gains tax we’d have to pay. The property didn’t rise much in value before we moved here full-time, but since making the improvements, it’s risen in value quite significantly. What would we end up paying in capital gains tax?

— The Rs

A: The payment of capital gains tax applies to all property, however Canada Revenue Agency offers an exemption that shelters any capital appreciation on your principal residence from being taxed.

The rules are fairly straightforward and basically include the following (there are nuances, so keep this in mind): A primary residence can be a cottage, trailer, detached home or condo. Only one primary residence can be claimed by a family unit (meaning your spouse can’t claim a different primary residence). Only one primary residence in a given year. You don’t need to sell property for it’s deemed disposition to change.

Ask Home Owner columnist Romana King your real estate question »

It’s this last bit that applies to you. According to the CRA a deemed disposition is a change of use in a property. In your case, you changed the use of your vacation property (to your primary residence) after you sold your home and moved in to the vacation property 14 years ago.

From a tax perspective, you owe tax on any price appreciation in the first 14 years you owned the property. However, for the remaining 14 years—when you lived in the property as your principal residence—any appreciation in value is exempt from capital gains tax.

To illustrate my point, here’s an example:

You buy the land and the vacation property 28 years ago for $100,000.

Fourteen later you sell your home (exempt from capital gains tax) and move into your vacation home. At that time, the vacation home has appreciated in value to $125,000.

For the next 14 years you improve the property and, this year, decide to sell. You sell it for $725,000.

For tax purposes you would owe capital gains tax on $25,000 ($125,000 value when you changed the primary use of the property minus $100,000 initial purchase price).

You would be exempt from paying capital gains tax on the additional $600,000 in appreciation ($725,000 sale price today minus $125,000 fair market value price 14 years ago).

If you were in a 30% tax bracket you would end up owing $3,750 in capital gains tax on the sale of this property ($25,000/2 = $12,500 x 30% = $3,750), leaving you with $721,250 of untaxed revenue (assuming no mortgage and not including real estate transactional fees).

Please keep in mind, however, that there are specific rules when it comes to appreciation of homes that are on land that is larger than 1.25 acres. If you own a lot of land, you will want to consult with the CRA on how much land is included and excluded from the capital gains principal residence exemption.
Read more from Romana King at Home Owner on Facebook »

6 comments on “Capital gains tax: Declaring the cottage ‘principal residence’

  1. What happens in the case of change of use from a rental property to Principal residence {not being sold] can you make a declaration of value to this effect and postpone payment of tax until the property is actually disposed of?

    Thank you

    Reply

    • Hi jwhitefro:
      Great question. And yes, the same applies. Again, the CRA will consider this a deemed disposition as it is a change of use to the home. But until you actually sell the property you can defer the taxes owed on this deemed disposition. To illustrate, let’s assume you purchased the place in 2010 and immediately started renting it out. Then in 2015 you moved into the home yourself as your primary residence. If you then sold the home in 2020, you would not owe tax on the appreciation of the property from 2015 to 2020, but you would owe tax on the appreciation from when you bought it in 2010 to when you changed the use of the property (from rental to primary residence) in 2015.
      My suggestion would be to pay a couple of hundred dollars to get an appraisal now. That way when the CRA asks for documentation on the value of the property you have an independent appraisal to justify your calculations.
      Hope this helps.

      Reply

  2. Hi Ramona. Thanks for writing this. I’m curious though – what if a homeowner is in the reverse situation meaning that they purchased a home as a principal residence and then years later, that property became a rental unit and the homeowner moved into another principal residence. How are capital gains calculated then? Thanks!

    Reply

    • Hi UKM:
      Whenever there is a change in use on a property the Canada Revenue Agency considers this a “deemed disposition.” This means the CRA acknowledges that you have not actually sold the property but you have changed the primary use. From a tax perspective this allows you to shelter the sale of this property from capital gains tax during the years that the property was your primary residence, but you must pay tax on the capital gains on any appreciation to the property in the years that it was used as a primary residence.

      Reply

      • Hi Romana,

        Don’t you mean -” but you must pay tax on the capital gains on any appreciation to the property in the years that it was (but instead wasn’t) used as a primary residence.”

        Reply

  3. Hello, Thank for the perspective on this topic. I have one nuance to the write up on what happens the day you deem the cottage property as the principle residence. If you deem the cottage property as your principle residence and it has appreciated above your purchase price, but at the same time you have incurred renovation expenses with the cottage up to the change of use date. At the time when you change to Principal Property, can you not deduct from the taxable gain any renovation or repair cost you have incurred against the value of the cottage that is subject to Capital gains? As a simple example Purchase priced $250K. Renovations and repairs $250K. Market value at time of change of designation to Principal residence $500K. Would capital gains be zero?

    Reply

Leave a comment

Your email address will not be published. Required fields are marked *