The Basics About Real Property Capital Gains Tax
This is some general information on capital gains as they pertain to secondary residences/cottages. When individuals have a house and a cottage it is worth consulting an accountant, as the accountant may have special approaches that can minimize tax.
The home or the cottage is known as a capital item for income tax and under those circumstances it is a capital gain/loss whenever it is a deemed disposition, on death or sold. The sale of a principal residence is generally tax-free, a second property generally is not.
To designate a property as the principal residence, it does not have to be the place where the taxpayer lives all the time.
If you have a home and a cottage and sell one of them at a profit, you must decide whether to designate the sold property as your principal residence. If you have a significant gain to date on your home, but a small gain on the sale of the cottage, it might be best to save the exemption for the sale of your home.
If you own multiple properties over a set period, it is best to determine which property increased the most in value during that period and that should be your principal residence declared for exemption. However, it is not just how much the property increased in value which you could determine by consulting a designated Appraisal Institute of Canada appraiser, but also what you have spent on each property that may be able to be deducted.
In Canada, 50% of any capital gain is taxable.
It’s relatively simple to calculate the capital gain when you sell a property. It’s the selling price less what you paid for the property, less certain expenses you incurred while you owned it that were aimed at improving the property. These are called capital expenditures.
For example, if you bought a cottage for $200,000 and you sold it for $250,000, your capital gain would be $50,000. 50% of this amount is taxable. You would be taxed on approximately $25,000.
If you gave the cottage to your children instead—the one you purchased for $200,000—and its fair market value (FMV) is estimated at $240,000, you will be considered to have generated a capital gain of $40,000. You will be taxed on this gain, even though you gave the cottage away.
If your kids then resell the cottage for $300,000, they’ll also be taxed on the extra $60,000 in increase in value.
CALCULATION OF CAPITAL GAIN TAX:
Sale price, minus the selling costs, minus capital improvements made to the property, and minus your adjusted cost base (ACB) or acquisition cost = CAPITAL GAIN.
If this resulting number is negative, it is a CAPITAL LOSS.
It is very important to keep a well documented binder or electronic folder for each real estate property you own. Many expenses you incur over the many years you own the property can be deducted from the otherwise potentially large capital gain.
Possible items to consider:
Original purchase price and fees relating to the purchase (real estate fees, lawyer fees, land transfer tax, appraisal fees, surveying costs)
Costs relating to the years of ownership such as aesthetic improvements, landscaping, driveway, decks
Any fees relating to the sale (marketing cost, real estate fees, lawyer fees, appraisal fees)
Any renovations that qualify as capital expenses can be added to your adjusted cost base (ACB) and used to reduce your capital gain.
As defined by Canada Revenue Agency: a capital expense “provides a lasting benefit and/or improves the property beyond its original condition.”
Roof: Upgrading the roof from shingles to metal would qualify as a capital expense as this is an upgrade.
Flooring: Replacing carpet with carpet would be considered a current expense while replacing carpet with hardwood would be considered a capital expense as it is considered an upgrade.
Generally, people do not try to include utilities costs (classed as “current” costs) if they have been using the cottage for their own enjoyment and recreation.
50% of a capital gain is taxable and is added to your other sources of income for the tax year. A large capital gain—for example, on a piece of real estate—can easily push you into a higher tax bracket.
Another consideration is whether a capital gains exemption was declared in 1994 if you acquired the property prior to that time. An exemption of up to $100,000 was available until 1994 and taxpayers were allowed to bump up their cost base on eligible capital property like cottages by up to $100,000 on their tax returns that year.
What if I decide to give the property to my child? Gifts are not taxable in Canada, but whether your child pays you the property’s full fair market value, a partial value or nothing, the transfer or sale is still deemed to take place at the fair market value. You cannot use an artificially low value to reduce or avoid the capital gains tax.
Clearly, it is a complex situation which warrants consultation with an accountant and or an estate planning professional.