Cottage Planning Conversation, Part 1: Dealing with Tax on Your Cottage

Clients and friends,

These hot summer months make the decision to pack up and head to the family cottage or cabin an easy one. Plus, after several months in the Ontario provincial lockdown, a trip to the lake provides an ideal escape.

Many of our vacation homes have grown in value in a big way in the past year or so. Unfortunately, with this increased value can come a spike in taxes when you decide that it’s time to sell, transfer ownership, or when you pass away. This can result in added stress, with questions like: “How much tax will eventually be owing on the property?”, “When will those taxes be due?”, and, “What can be done to manage that tax?”

The ultimate challenge here is to minimize your tax liability. Here’s what we can do about it:

  1. Maximize Your “Adjusted Cost Base” (ACB). You can only be taxed on the value of your property over and above your “Adjusted Cost Base” or cost amount above the sales price. Any improvements you’ve made to the property over time count towards your ACB. Typically, we pay less tax because these things usually increase the cost basis and decrease the capital gains. Work to pull these items together and hold onto them going forward. 
  2. Claim the “Principal Residence Exemption” (PRE). The key to the definition of “Principal Residence”, here, is that you must “ordinarily inhabit” the space; no length of time is specified. This means, in general, that you could claim the “Principal Residence Exemption”, to shelter all or some of the gain upon the sale or transfer of the property, or upon your passing. While many people tend to list their primary home as their Principal Residence, this might be something to consider as property values of cottages continue to soar. 
  3. Transfer Ownership. In this “estate freeze” of sorts, you would not face any tax on any future growth on the property. Instead, the future growth, and associated tax bill are attributed to the next generation. Yes, the potential challenge, then, might be paying tax upon that transfer, but this is not guaranteed. If you do end up having to pay tax, it’ll be paid at today’s capital gains inclusion rate, which is likely better than what’s projected for the future.
  4. Consider Life Insurance to Cover Your Taxes. A final easy solution to manage vacation home taxes is through the purchase of a permanent life insurance policy, to cover those taxes upon your death. This idea allows for your heirs to fund the taxes owing should they wish to keep the cottage but don’t have enough in liquid assets to cover it. What’s more, a permanent life insurance policy allows for the tax-free accumulation of cash value.

A cottage or cabin is a place for fun, family time, rest, and relaxation and tax stress eats away at those plans. Let’s chat today about a plan for your cottage now, and into the future. Stay tuned for Part 2 of our Cottage Planning Conversation in the coming weeks.

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