How to Avoid Capital Gains Tax on a Cottage

Property values in Ontario’s Cottage Country have risen sharply over the past several years, presenting ideal conditions for cottage owners who are looking to sell. However, with this growth comes special considerations – such as capital gains tax.

If you’re planning on selling your cottage, it’s essential that you understand how capital gains are calculated and taxed.

Here’s the good news: Cottage sellers can employ a diverse range of strategies to reduce the impact of capital gains tax, or in some cases, avoid it altogether.

In this blog, we’ll look at various strategies on how to avoid or reduce capital gains tax in Canada, when they’re applicable, and what sellers should know before they implement them.

Note: Taxation is a complex topic, with regulations consistently shifting and evolving. For more personalized advice, consult a professional directly.

What is Capital Gains?

Let’s start with the basics: what exactly is capital gains? In real estate terms, capital gains refer to the difference between the upfront and ongoing costs of a property (in this case, a cottage) and the money made when it is sold. In other words, it’s a specific type of profit made from the individual sale of a single asset.

For example, if you purchased a property for $500,000 and sold it for $1,000,000, your capital gains would be $500,000. This is assuming you didn’t make any qualifying capital improvements.

How Does Capital Gains Tax Work in Canada?

For Canadians, the profits earned from selling a principal residence (i.e. your main home) are tax-exempt. Conversely, the capital gains earned by selling a non-principal residence, such as a vacation home or an income property, will be subject to taxation.

In Canada, the inclusion rate for capital gains tax is 50%. So, if your cottage capital gains totalled $500,000, you would be taxed on $250,000. Once calculated, your taxable earnings are subject to your personal federal and provincial income brackets or marginal tax rates.

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How to Avoid Capital Gains Tax on Property in Canada

If you’re looking to completely bypass capital gains tax after selling your cottage, there’s only one primary method of doing so – the principal residence exception.

What is the Principal Residence Exemption?

Arguably, the most effective method of avoiding capital gains tax in Canada is the principal residence exemption. While certainly beneficial, it’s not always the catch-all tax shelter that certain sellers expect.

Here’s how it works: If you own more than one property, you can choose which one you designate as your primary residence (including your cottage). Remember, capital gains earned from the sale of a primary residence are tax-exempt, which allows you to avoid taxation.

Keep in mind that other requirements or exemptions may apply. It’s a good idea to talk to your accountant or a cottage real estate agent to find out if you may be eligible for this strategy.

Optimizing Your Adjusted Cost Base

If you’re not able to avoid capital gains tax completely, there are steps you can take to reduce what you owe, such as diligently calculating your adjusted cost base (ACB).

Rather than calculating capital gains based on the price you initially paid for your cottage, you’ll be comparing your sale returns to an ACB. Your ACB is essentially the sum of the upfront and ongoing costs you’ve put into your cottage, including things like property upgrades, legal fees, inspections or surveys, real estate agent commissions, and more.

For example, let’s say once again you paid $500,000 for your cottage, but have invested $100,000 in renovations since you’ve owned it. This gives you an adjusted cost base of $600,000.

Renting Out Your Cottage Instead of Selling

You can potentially avoid capital gains tax by choosing to maintain your cottage as a dedicated income property instead of selling it.

At Cottage Vacations Real Estate, we’re Cottage Country’s investment property experts. To help you decide which path is right for you, our team will break down the potential income earned from renting out your cottage compared to its potential sale value. If you decide to go the income property route, we can help you set up and manage your cottage rental, ensuring you’re positioned for a smooth and profitable venture.

Ready to Sell Your Cottage?

If you’re looking to maximize the returns for your cottage sale, you’ll want to partner with professional experts who know Cottage Country inside and out. That’s where we come in – Cottage Vacations Real Estate.

With your interests top of mind, we’ll create a strategic plan for selling your property to meet your goals, within your timeline. Leveraging an extensive database of qualified, vetted buyers that we can match with your cottage, our connections mean faster sales, fewer carrying costs, and stronger offers.