How to calculate capital gains on a cottage in Canada? You should know about capital gains before you invest in such properties. In this article, we will discuss all those crucial factors and a guideline for calculating them.
Many Canadians choose to invest in second homes, vacation homes, or rental cottages where they can enjoy a summer vacation. Yet, these homes aren’t covered by the primary residence exemption.
This means when you sell your vacation home, you’ll have to pay capital gains taxes on it, just as if you were selling a rental home. Here’s what that tax looks like and what it means for you.
- 1 How to Calculate Capital Gains on a Cottage in Canada?
- 2 How Do I Avoid Paying Capital Gains When Selling a Cottage?
- 3 Can I Use the Primary Residence Exemption?
- 4 How Do I Reduce Capital Gains on My Cottage?
- 5 What is Deemed Disposition, and How Do I Avoid it?
- 6 Who Do I Have to Pay If My Cottage is in the United States?
- 7 See also:
- 8 Need Help With Your Real Estate Issues?
How to Calculate Capital Gains on a Cottage in Canada?
Capital gains taxes work about the same way in every case, regardless of what you use the property for. If your home isn’t your primary residence, then 50% of the gains become taxable.
Here’s how this works. First, you calculate the Adjusted Base Cost (ABC) of your cottage. That is:
- The price of the home at the time of purchase.
- The closing and transaction costs.
- The capital improvements you’ve made on the property.
Say you paid $200,000 for your cottage, including closing and transaction costs. Over the years you updated the kitchen, put on a new roof, and bought a new water heater. You spent $50,000 on those improvements, so the ABC is $250,000.
You then sell the cottage for $350,000. Your taxable capital gains are $100,000…not $150,000.
You then add that $100,000 to your income, whatever it is, and pay the tax on your income according to your tax bracket. You’d take all the normal exemptions, adjustments, and write-offs.
In the top income bracket? That puts you at 33%…or $33,000 in tax on the capital gains before any of those exemptions or deductions are accounted for.
While most people don’t love the idea of paying capital gains on their vacation property, the truth is you will still come out quite a bit ahead after the sale if you’ve owned your property for some time. Property values in Canada can rise as high as 81% after you’ve owned the property for 10 years. So while the amount seems hefty, it’s only hefty in proportion to what you stand to gains.
Remember, you must know how to calculate capital gains on a cottage in Canada. Because if you don’t know about it, you may get into legal trouble after buying a cottage.
How Do I Avoid Paying Capital Gains When Selling a Cottage?
There’s no real way to avoid paying capital gains taxes. There are some strategies for reducing the tax, but they won’t get you off the hook entirely.
The only real way to avoid paying the tax would be to convert the home into an income-generating rental home instead. If you don’t sell the house at all, you don’t pay capital gains taxes, though you would pay taxes on any rental income you receive.
You’ll pay taxes one way or the other. You might as well pay taxes in the way that best serves your financial needs.
Can I Use the Primary Residence Exemption?
Possibly. If you spent most of the year there and have only used the home as a resident, you might claim it. You can only claim one home as your primary residence at a time each year, so there could be other tax consequences for doing this.
This will only lower your taxes, not eliminate them. For one thing, eventually, you’ll have to sell the other home too.
The formula here is:
(# of years home is principal residence + 1) x capital gain
# of years home is owned
Thus, you’ll be able to lower your taxes a little bit, but you won’t be able to eliminate them entirely, and you’ll incur a similar capital gains tax on your other residence should you choose to sell that home. You can own two homes and even live in them in any proportion you want, you just can’t coyly switch back and forth between the two at selling time to keep from paying any taxes at all.
How Do I Reduce Capital Gains on My Cottage?
The best way is to keep careful track of your capital expenditures. When you have work done on the cottage, keep the receipts. You can use that to raise your Adjusted Base Cost later.
Chances are you’ve had the work done over the course of years. This is the cash-flow-friendly option that can save you thousands.
What is Deemed Disposition, and How Do I Avoid it?
Sometimes, for tax purposes, you must treat the property as if it was sold even though it wasn’t. For example, if you gift the property to someone else, you have to pay capital gains on it as if you’d sold it for its fair market value at the time.
If you change a property from personal use to business use or investment use, or vice versa, then the property is deemed to have been sold at its fair market value, and you’ll pay capital gains tax at that time.
This situation also arises when the property owner dies. The estate may claim a capital loss or pay capital gains tax as appropriate before passing the property onto any heirs. There are special tax rules for capital gains and losses in the year of death.
Who Do I Have to Pay If My Cottage is in the United States?
You have to pay both the CRA and the IRS. Canada requires you to pay the appropriate tax on capital gains on any investment income earned worldwide. In addition, you’ll have to pay the US capital gains tax, though the laws in the United States are very different.
Consult with a real estate lawyer and a tax professional to ensure you’re handling international taxes correctly.
Need Help With Your Real Estate Issues?
We hope now you’ve understood How to Calculate Capital Gains on a Cottage in Canada. Our legal team has decades of real estate experience. Make sure your interests are protected when you buy or sell your real estate. There are many issues to tackle, and we help with all of them. Call (780) 488-4152 to set up an appointment today.