By: Jayson Schwarz LLM
Right now the cottage is a refuge from the bustle of rush-hour traffic, business and taxes; however, when the time comes to sell it or pass it on to your family, you will have to face the tax consequences of selling (or “disposing of”) it. When selling real property, any increase in its value since the time you purchased it is characterized as a “capital gain”. The tax law right now requires that 50% of a capital gain comes into income and is taxable. There are, however, several ways to minimize, or even fully be exempt, from having to pay that tax.
The main exemption from the capital gains tax on real property is the “Principal Residence” exemption. Real property that is your principal residence is exempt from capital gains tax, but there are some strict rules that must be followed. First of all, you may only claim one property as your principal residence. This means that if you have a home in the city and a cottage, you must designate one as your principal residence in order to reap the benefit of the exemption upon disposition. According to the Canada Revenue Agency’s Income Tax Bulletin IT-120R6 (at paragraph 5), the property must be “ordinarily inhabited” in the taxation year in which the exemption is being claimed “by his or her spouse or common-law partner, former spouse or common-law partner, or child.” “Ordinarily inhabited” is a question for the tax court to decide, but speaking with a lawyer can help you determine whether you meet this exemption, which can save you a significant amount of money.
Make it your Principal Residence
Even if you only inhabit your cottage on a seasonal basis, the bulletin states that “a seasonal residence can be considered to be ordinarily inhabited in the year by a person who occupies it only during his or her vacation, provided that the main reason for owning the property is not to gain or produce income.” It is important to note that these bulletins are not law, though they help guide the interpretation of the Income Tax Act. A lawyer should be consulted to see if your facts will fit into the exemptions that are designed to save you tax dollars.
Unwilling to Will
If you are unable to fit into the complete exemption, there are other ways to bypass the tax. Trying to gift it for a nominal fee, or will it upon death, are not great ideas as those methods will expose your beneficiaries to the capital gains tax. Dispositions in those ways will be deemed to have occurred at fair market value. One way of dealing with this is by taking out a life insurance policy specifically for the purpose of covering the tax when it is willed to family on your death.
In Trusts we Trust!
One popular way of keeping a cottage in the family without exposing it to tax is by allowing a trust to own the cottage. Taxes can be deferred if the trust is properly structured, and any beneficiary of the trust will be able to use and control the cottage as you deem fit. Trusts are great vehicles for controlling and conveying assets and capital, and should be explored with a lawyer who has expertise in structuring them.