Due to the earlier ‘Principal Residence Exemption’ (PRE) tax rules, which did not require taxpayers to report the sale of the residence, many individuals claimed the PRE for multiple properties, which included recreational properties, such as cottage. This led the Canada Revenue Agency (CRA) to update the Canada Principal Residence Exemption (PRE) reporting requirements. Taxpayers are now required to report the sale of a principal residence on their tax return, and may need to file Form T2091, Designation of a Property Principal Residence when the principal residence exemption does not fully eliminate the capital gain from taxes.
The following is an overview of the tax rules related to the ownership and sale of a recreational property (cottage) in Canada.
Recreational Property Canadian Tax Consequences
If a Canadian resident is considering selling off their recreational property, such as a vacation house, cottage, or other similar secondary property, the following tax points should be kept in mind:
Principal Residence & Secondary Residence (Recreational Property/Cottage)
According to the Canadian tax rules, a principal residence can be a house, apartment or cottage that is occupied by the owner, or by his/her spouse, domestic partner or children. If a portion of the home is used for business or rental, then only the portion used personally qualifies as a principal residence. A person may only designate one residence as his principal residence for any given year.
Recreational properties and/or cottages that are only used for short durations during a year, may still qualify as a ‘principal residence’ if the residence was solely purchased for vacation purpose and not to earn income. Many recreational property owners rent out their vacation properties during the year, and sometimes only to breakeven with the property management expenses may fail to have their recreational property considered a ‘principal residence’ for tax purposes.
In addition, for the purpose of designating a property as a principal residence, couples are considered as one individual. That is, they may only designate one property as a couple.
Therefore, sellers often end up paying taxes on capital gains that result from the sale of recreational properties.
Firstly, because the house fails to qualify as ‘principal residence’ for claiming full exemption (as mentioned above), and secondly, if one of the houses is owned by the taxpayer and the secondary or recreational property is owned by the spouse, the ownership is considered as one.
When a couple has two properties eligible to designate as a ‘principal residence’, it is often advised to designate the property with the higher gain as the ‘principal residence’.
Capital Gains Tax on Sale of Recreational Property
When a cottage is sold, tax is payable on any capital gain, less any principal residence exemption. If there is a capital loss, the loss is not deductible, because losses on personal-use property are not deductible except for listed personal property (LPP) losses, which may only be deducted from LPP gains. Real estate is not considered LPP.
It is important to keep a record of the adjusted cost base of both the primary home and the cottage, to be used to calculate the gain on sale, because the principal residence exemption could apply to either property. Be sure to keep receipts not only for the purchase of the property but any improvements that have been made such as a deck, fence, etc.
Claiming Principal Residence Exemption (PRE) for the Recreational or Vacation Property
As mentioned above, the Canada Revenue Agency (CRA) has updated the PRE regulation. Under the updated regulation, the taxpayer is required to report the capital gains from the sale of the property on their annual income tax return in the year of sale along with filing a Schedule-3 to report the capital gain. If the property does not qualify or is not designated as a principal residence for all the years it was owned, filing the Form T2091 is mandatory to designate the property as principal residence.
Determining which property to designate as ‘principal residence’ for effective tax planning can be tricky. If an individual owns more than one property and is in the process of selling or considering selling his property, it is highly recommended that he/she consult a Canadian real estate tax expert before finalizing the deal.
Gifting the Vacation or Recreational Property
Parents often wish to gift their vacation/recreational property to their children. Property owners should be aware that if they transfer the property to their children, it would be subject to immediate capital gains tax on any changes in the current fair market value of the asset and the adjusted cost basis.
However, transferring to the spouse or common-law partner, while alive or upon death is considered as a roll-over of asset at its adjusted cost basis with no reportable capital gains.
Other Tax Considerations for Recreational Property
In addition to income taxes, some provinces levy additional taxes. B.C.’s foreign buyers’ tax, property transfer tax, vacant house tax and Ontario’s Non-resident Speculation Tax are some of them. If you are contemplating purchasing a recreational property, it is highly recommended to be informed about these. Upon the sale of property, the owner/seller should also keep these taxes in mind since he/she could be held liable if the buyer does not pay the required taxes.
It is highly recommended that Canadian individuals reach out to a tax practitioner before purchasing a recreational or vacation property such as a cottage, and again before selling the property. This will help the taxpayer prepare for the possible tax consequences, and avoid any unnecessary tax burden.
Keep in mind that the Canada Revenue Agency (CRA) has tightened the PRE reporting requirements, and the audit process. Therefore to avoid any problems during the years of ownership and during sale it is highly recommended to consult a tax practitioner, regardless of whether the individual is considering a vacation property in Canada, the U.S. or any other foreign country.
AG TAX LLP CAN HELP
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of US and Canadian tax laws as well as cross-border compliance.
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