Capital gains tax: Declaring the cottage ‘principal residence’

Q: We bought property 28 years ago which we used as a weekend getaway for 14 years. There were a few small buildings on the property, but no significant home on the lot. The largest building was a garage. We then sold our home and moved to this property fixing up the garage making it into a small cottage. In other words, this became our principal residence for the next 14 years and we continued to make improvements to the home and the property. Now we’d like to sell it, but we’re not sure what capital gains tax we’d have to pay. The property didn’t rise much in value before we moved here full-time, but since making the improvements, it’s risen in value quite significantly. What would we end up paying in capital gains tax?

— The Rs

A: The payment of capital gains tax applies to all property; however, Canada Revenue Agency offers an exemption that shelters any capital appreciation on your principal residence from being taxed.

The rules are fairly straightforward and basically include the following (there are nuances, so keep this in mind): A primary residence can be a cottage, trailer, detached home or condo. Only one primary residence can be claimed by a family unit (meaning your spouse can’t claim a different primary residence). Only one primary residence in a given year. You don’t need to sell property for it’s deemed disposition to change.

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It’s this last bit that applies to you. According to the CRA a deemed disposition is a change of use in a property. In your case, you changed the use of your vacation property (to your primary residence) after you sold your home and moved in to the vacation property 14 years ago.

From a tax perspective, you owe tax on any price appreciation in the first 14 years you owned the property. However, for the remaining 14 years—when you lived in the property as your principal residence—any appreciation in value is exempt from capital gains tax.

To illustrate my point, here’s an example:

You buy the land and the vacation property 28 years ago for $100,000.

Fourteen later you sell your home (exempt from capital gains tax) and move into your vacation home. At that time, the vacation home has appreciated in value to $125,000.

For the next 14 years you improve the property and, this year, decide to sell. You sell it for $725,000.

For tax purposes you would owe capital gains tax on $25,000 ($125,000 value when you changed the primary use of the property minus $100,000 initial purchase price).

You would be exempt from paying capital gains tax on the additional $600,000 in appreciation ($725,000 sale price today minus $125,000 fair market value price 14 years ago).

If you were in a 30% tax bracket you would end up owing $3,750 in capital gains tax on the sale of this property ($25,000/2 = $12,500 x 30% = $3,750), leaving you with $721,250 of untaxed revenue (assuming no mortgage and not including real estate transactional fees).

Please keep in mind, however, that there are specific rules when it comes to appreciation of homes that are on land that is larger than 1.25 acres. If you own a lot of land, you will want to consult with the CRA on how much land is included and excluded from the capital gains principal residence exemption.
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