Understanding Capital Gains Tax on Real Property
Capital gains tax is a critical consideration for owners of multiple properties, such as a primary residence and a secondary residence or cottage. It is advisable to consult with an accountant, as they may offer specialized strategies to minimize tax liabilities.
Capital Gains and Losses in Real Estate
In the context of income tax, both a home and a cottage are classified as capital assets. Consequently, the sale or deemed disposition of these properties, including instances of inheritance or death, results in a capital gain or loss. While the sale of a primary residence typically does not incur tax, the sale of a secondary property usually does.
Principal Residence Designation
A property does not need to be your habitual residence to be designated as your principal residence. When selling either a home or a cottage at a profit, it is crucial to decide which property to designate as your principal residence. This decision should be based on the comparative gains of each property. For instance, if your home has accrued a significant gain but your cottage has not, it might be more beneficial to apply the exemption to your home.
Optimizing Principal Residence Exemption
For those owning multiple properties over a certain period, it is advisable to declare the property with the highest value increase as the principal residence for exemption purposes. This decision should factor in both the property's appreciation and the capital expenditures on each property, which can be assessed by a professional appraiser from the Appraisal Institute of Canada.
Taxation of Capital Gains in Canada
In Canada, 50% of any capital gain is subject to taxation.
Calculating capital gains is straightforward: subtract the original purchase price and any capital improvements from the selling price. For example, a cottage bought for $200,000 and sold for $250,000 results in a $50,000 capital gain, of which $25,000 is taxable.
Capital Gains on Gifts
Transferring a property as a gift, such as giving a cottage to your children, does not exempt you from capital gains tax. The capital gain is calculated based on the fair market value at the time of the gift, and any subsequent sale by the recipient is also subject to capital gains tax on the increased value.
Capital Gain Tax Calculation
The formula for calculating capital gain tax is: Sale price - selling costs - capital improvements - adjusted cost base (ACB) or acquisition cost. A negative result indicates a capital loss.
Maintaining detailed records for each property is essential. This documentation should include the original purchase price, fees associated with the purchase and ownership, and any capital improvements. These records are crucial for reducing potential capital gains.
Renovations that qualify as capital expenses can be added to your ACB, reducing your capital gain. The Canada Revenue Agency defines a capital expense as one that provides a lasting benefit or improves the property beyond its original condition.
Tax Bracket Consideration
It's important to note that 50% of a capital gain is taxable and is added to your other income for that tax year, potentially pushing you into a higher tax bracket.
1994 Capital Gains Exemption
For properties acquired before 1994, it's worth investigating whether a capital gains exemption was declared, as an exemption of up to $100,000 was available until that year.
Transferring Property to Family Members
In Canada, while gifts themselves are not taxable, the transfer of property to a child is considered to occur at the property's fair market value, regardless of the actual transaction value. This rule prevents the use of an artificially low value to reduce or avoid capital gains tax.
Given the complexity of these issues, it is highly recommended to seek advice from an accountant or an estate planning professional to navigate these tax implications effectively.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.