It is summer once again — and cottage and cabin season is well underway. However, this year has brought new potential challenges for cottage and cabin owners. Given proposed increases to the capital gains inclusion rate,* when the property is eventually transferred or sold, there is likely to be a higher tax liability. Some realtors claimed that the spring brought “chaos,” with many cottage owners rushing to sell ahead of the June 25 deadline for capital gains tax changes.1
One of the most common issues that vacation property owners face is covering a potentially large capital gains tax liability triggered upon its transfer, especially if they wish to keep the property in the family. With real estate prices soaring, a cottage or cabin with a cost base of $500,000 could easily be valued at $1.5 million or more in today’s markets. Before the recent tax changes, only one-half of this potential $1,000,000 capital gain would be subject to taxes. Now, for realized gains over $250,000, two-thirds will be taxable. At the top marginal tax rate of 53.5 percent (using BC as an example), this change will result in an additional $66,875 tax liability, with a total tax bill of $334,375 or ($250,000 X ½ + $750,000 X ⅔) X 53.5% assuming no other realized gains. This is certainly not insignificant by any means.
As you think ahead to the eventual transfer or sale of a cottage or cabin, here are four things to consider:
Invest in life insurance — Insurance has traditionally served as a solution to cover such tax liabilities at death and may be a worthwhile consideration should you wish to leave the property for the next generation. This involves purchasing a policy with the death benefit equal to the expected tax bill. The proceeds will typically be paid tax free and may avoid probate fees (in provinces where applicable), allowing beneficiaries to cover the tax liability and keep the property in the family. You might even arrange it so that the annual premium cost is paid by the eventual beneficiaries.
Consider the Principal Residence Exemption (PRE) — If the property qualifies for the PRE, you may consider designating it as a principal residence. Since only one property can be designated in any given year, you will need to decide which to designate; this needs to be determined at the time you dispose of any property you own. While the decision is rarely straightforward and often requires considering multiple factors, such as predictions about the future value of the remaining residence(s), generally, you should consider designating the property with the largest average capital gain per year to reduce the overall tax liability.
Transfer ownership over time, where possible — If you are passing along the family vacation home within the family, you may wish to consider transferring ownership over time, where possible, such as to children or other family members. At the time of transfer, a capital gain at fair market value would be triggered on only the portion of the property you transfer and taxes would be due. For instance, if you transfer half of the ownership in the above example over two different years, you could potentially take advantage of the lower inclusion rate for $250,000 of capital gains each year. Using the 1/2 inclusion rate, instead of the 2/3 inclusion rate, could potentially save $22,292 in taxes. However, be aware that there may be intricacies or other consequences that arise with a co-ownership arrangement, so a tax advisor should be consulted before engaging in this planning.
Keep track of capital improvements — Make sure to document all capital improvements such as renovations, additions or upgrades that increase the property’s value. Be sure to save receipts. These can be added to the property’s cost base, which can reduce the associated capital gains taxes owed when the property is eventually transferred or sold.
*At the time of writing, the budget legislation has not been drafted or approved.
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