Q: I shared a cottage property with my brother. I sold my half to my niece. Do I have to pay capital gains tax? If so, how do you calculate this? How do you determine the adjusted cost base? What expenses can be applied?
A: The family cottage can provide a lot of lasting memories. But when it comes to sharing it with other family members, money can be an issue. In some cases, it’s figuring out what repairs to do next summer and who is going to flip the bill. In most cases, taxes eventually become a consideration as well.
In your case, Terry, it sounds like the sale of your half of the family cottage to your niece has already occurred. So the key is figuring out what tax implications will result.
Capital gains tax became payable in Canada in 1972. Prior to that, capital gains in this country were not subject to tax. A capital gain occurs when you sell certain assets for a higher price than what you paid for them.
Some assets are specifically exempt from capital gains tax. These include:
- Capital gains on an eligible principal residence
- Capital gains on qualified farm or fishing properties up to $1 million
- Capital gains on qualified small business corporation shares up to $824,176
- Capital gains on investments held in tax-sheltered or tax-free accounts like RRSPs, TFSAs or RESPs
You may be eligible to claim a principal residence exemption on the cottage proceeds, Terry. A taxpayer and their spouse are entitled to designate a property as their principal residence and claim a capital gains exemption for some or all of the years that it was owned by them. Prior to 1982, each spouse could designate one property as their principal residence for any given year, but after 1981, spouses could only designate a single property as their principal residence as a family unit for each year of ownership. This can include a cottage.
If you also own a home, Terry, it may not be advantageous to claim a principal residence exemption on the cottage sale. This is because you only own half the cottage and unless the capital gain is a large one, claiming it as your principal residence may open you up to a much larger tax bill on the sale of your home.
Let’s assume that you owned the cottage for 20 years and you claim a principal residence exemption on it, Terry. If you owned your home for all 20 of those years and you sell your home in the future after owning it for 40 years, 20 out of those 40 years you will have designated another property as your principal residence. This will make half of the capital gain—20 out of 40 years—taxable on the sale of your home.
A sale or even a gift of an appreciated asset to a family member—including a cottage—may result in a capital gain. Sales or gifts of assets to family members generally take place at fair market value, so using an artificially low value is not a viable way to reduce or eliminate a capital gain.
One exception to the fair market value rule is when a transfer is made of an asset from one spouse to another. This will generally take place at its original cost, unless you make a special election to transfer it at a value between the cost and the fair market value. The income or capital gain that results thereafter may, however, be attributed back to the gifting spouse.
In order to calculate your adjusted cost base or ACB for the cottage to determine the capital gain, you need to start with what you originally paid for the cottage, Terry. If you bought it prior to 1972 when capital gains tax became payable in Canada, the cost would be the fair market value in 1972.
If you bought the property prior to 1994, you may have already claimed an up to $100,000 capital gains deduction on the property. Prior to February 22, 1994, Canadians had a $100,000 lifetime limit for tax-free capital gains. Many Canadians who owned taxable capital assets like cottages at that time filed an election to claim a deemed capital gain based on the then fair market value of their cottage, which would generally become your new adjusted cost base for capital gains tax purposes.
If you inherited the cottage, as many people do, the fair market value when you inherited the cottage would generally be your cost for tax purposes, Terry.
Acquisition and disposition costs can be used to reduce the capital gain on the property. So expenses like land transfer tax, legal fees and real estate commissions would be common claims. If you made capital improvements or renovations to the cottage over the years, like a new roof, deck, dock or so on, these expenses increase the adjusted cost base and ultimately reduce the capital gain.
There are a lot of financial factors that apply when you buy, own or sell a cottage. It’s important to consider the implications, whether you do the research on your own or seek out input from a professional.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.