Q: How will the $200,000 tax-free capital gains affect our non-principal residence? Is each tenant entitled to $200,000? My wife and I are original owners / joint tenants of our cottage and we expect to sell before we hit the retirement home in a few years. The original building and properties costs were less than $10,000. Current assessment is $120,000. Our joint marginal tax rate is 20% and average tax rate 10%.
A: Cottages can be great for unwinding and spending quality family time. They can be expensive for maintenance costs and ultimately income tax.
Assuming that you have another home that you live in, Charles, there will be tax implications from the sale of one of your two properties. You can actually claim the principal residence exemption for your cottage, making the sale tax-free without limits, but I’m guessing that the capital gain on your house would be larger and more preferable to shelter from capital gains tax as your principal residence.
I gather with the reference to a $200,000 capital gains exemption that you are confused about the $100,000 lifetime capital gains exemption that existed in Canada from 1984 to 1994. Each spouse could take up to $100,000 of lifetime capital gains free of tax. Many Canadians took a deemed capital gain on their 1994 income tax return that pushed up the tax cost of certain capital assets for tax purposes–including their cottages–based on the market value at that time.
You should see if you guys did so, as this would reduce the ultimate capital gain on sale. However, there is currently no $200,000 capital gains exemption, Charles. And that $100,000 capital gains exemption is no longer available. The only capital gains exemption that exists currently relates to the sale of private company shares or an eligible farm. It is up to $813,600 per spouse.
Given the $10,000 cost and $120,000 market value, there is a capital gain of $110,000 currently. Any capital expenses or renovations over the years would be added to the cost for tax purposes. Selling costs like real estate commissions and legal fees would be deducted from the proceeds. If we assume a net capital gain of $100,000 after transaction costs, $50,000–or one-half–is taxable in the year of sale.
If you’re in a 20% marginal tax bracket, I’m going to make an assumption for discussion purposes that your income is $30,000 and that you live in Ontario, Charles. The taxable capital gain of $50,000 would be allocated–$25,000 each–between you and your wife. So your taxable income would be $55,000 with a new marginal tax bracket of 31% and average tax rate of 18%. Depending on your sources of income and tax credits, you might incur about $7,000 of income tax each on the sale.
If you own two pieces of real estate at any given time in Canada, unless one has gone down in value from your original purchase price, you’re sitting on an eventual taxable capital gain. The exception may be for a farm property, but specific criteria apply. The income inclusion is reduced somewhat given that only half of a capital gain is taxable and that it’s often split between two spouses, but it’s important to plan for eventual taxation of all of your property–whether on sale or on death.
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 whatsoever.