CRA your silent partner when selling a summer propertyLast year was a seller's market for summer homes. With the pandemic and lockdown, city folks were paying premium prices for a place by the water. This year might be an even hotter market for sellers – the pandemic is still with us, and restrictions are slowly easing, but it feels like people are even more determined to get out of the city after not being able to travel for over a year. So demand is high. And if you are thinking of cashing in on that demand as a seller, then consider the following tax issues before you decide to put the "For Sale" sign up.
Tax consequence of a sale
Many, many years ago, a family was eligible for a double principal-residence exemption. However, in the early '80s, the tax rules were changed so that now there is essentially a one-principal-residence-per-family rule (with some tax relief still potentially available for second properties owned prior to 1982). What this means is that if you sell or transfer the cottage, capital gains tax may be payable on your "home away from home."
You should assume a tax rate on capital gains of about 26.7% (Ontario rates) on the appreciation in value. So any sale of the cottage at today's value will result in a capital gain equal to the sale price less the "adjusted cost base" of the property to you. The "adjusted cost base," in a nutshell, is the cost you paid to acquire the property plus all capital improvements you made to the property over the years. If you, like many cottagers, inherited the cottage from previous generations by way of will, your cost of the property will be equal to the fair market value of the cottage at the time that you inherited it.
You should also ask yourself whether you have owned the cottage since before 1972. Why that far back? Well, if you owned property prior to Dec. 31, 1971, you were able to take advantage of "Valuation Day," or "V-day."
Since capital gains were only taxable from 1972 onwards, the increase in value of your cottage prior to Dec. 31, 1971, is exempt from capital gains tax. Accordingly, you were able to elect the fair market value of the property as at Dec. 31, 1971 to be your new cost base for future capital gains calculation purposes. So if you did own your cottage prior to V-day, you may want to check to see what your V-day value is in order to determine what your effective cost base would be. Plus, if you made any capital improvements since V-day (presumably this would be the case since your cottage likely would have required some work over the past 49 years), those improvements can be added to your V-day value in determining your adjusted cost base.
As mentioned above, you can no longer double up on your principal residence exemption, which means that you have to designate either your principal home or your cottage in order to get the exemption. If you think that your capital gain on the sale of the cottage would heavily outweigh any possible gain on the principal home for those years that you owned both, then you may want to designate your cottage as your principal residence and claim the exemption. However, this becomes an exercise in numbers to determine where your biggest tax liability lies.
Transfer within the family
In many cases, you may want to rid yourself of the cottage but still keep it in the family by transferring it to a family member (i.e., your kids or grandkids) for estate-planning or other reasons. However, our tax rules are clear: If you transfer a capital asset – be it a second home or otherwise – to a related person other than your spouse, there is a "deemed sale" of the property at its current market value at the time of transfer. This could then trigger capital gains tax to you (even though you didn't actually sell the property or receive any proceeds).
One of the most dangerous examples of this tax trap awaits those readers in provinces that have a probate tax. A common strategy is to change the title to the cottage from one person to joint tenancy with another person in order to avoid probate fees on estate of the first to die. But CRA will treat this as a deemed sale of the property at current value to the extent that new joint tenants (other than a spouse) come into the picture.
Suppose, for example, that you decide to put your home in joint tenancy with your two children. CRA's position is that you will have sold two thirds of your property to your kids. Furthermore, since each child now owns a third of the home, the availability of the principal residence exemption for each one-third interest will depend on the individual circumstances of yourself and each child.
On some occasions, taxpayers who have unwittingly fallen into a transfer/deemed sale trap have been able to convince the CRA that they held the property "in trust" for their children – i.e., that their kids have been "beneficial owners" of the property all along. However, this can be an uphill battle and must be supported not only by the particular circumstances but also by proper documentation. For example, it is possible that earlier statements listing ownership of assets provided to a financial institution could trip you up.
Previously published in The Fund Library on July 6, 2021 by tax and estate planning lawyer
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.