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Given the potential for appreciation of a cottage, it is imperative to protect yourself from taxes on capital gains.

According to John Natale, chief of tax, retirement and estate planning services at Manulife, a cottage could be taxed for its assessment in the event of the owner’s death. If not planned, the estate could be forced to sell.

“A cottage is expected to appreciate in value, but, unfortunately, that means that 50% of that profit will be taxable like any other capital gain,” Natale said. “To avoid it, assuming you qualify, and most of the people would do it, assuming that the rent is only auxiliary for the true purpose of enjoying the property, you can qualify under the principal residence exemption if you designate it as such. ”

If the capital gains tax is inevitable, there are ways to mitigate the cost. The owners of these recreation houses should keep a record of their cost bases, which should be maximized, Natale added. For example, if a renovation is done, adding a dock or building a roof, those updates increase the cost base, thus reducing capital gains.

Even so, it is always advisable to plan ahead. If the owner of the cottage transfers it to his children before he dies, the tax obligation is limited and any future capital gains become the responsibility of the heirs.

“Consider transferring the cottage to the next generation now, instead of waiting to die,” Natale said. “The benefits of doing so are multiple: you, as parents, have captured capital gains from now on when they are sold, so when the cabin is transferred to the next generation, any future growth is subject to taxes, so you have limited your fiscal responsibility.”

If the owner receives a promissory note and the payment does not exceed one fifth per year, the capital gain can be extended over five years, which means that only 20% per year should be reported.

“Actually, I could save taxes in general because of how graduated tax rates work,” Natale said. “Because you report a capital gain of 20% each year, it may allow you to remain at a lower tax level, while if you record 100% of the capital gain in a year, you could reach the higher tax level and in a province like Ontario would pay 53.5% of taxes on taxable capital gains in the upper range. ”

Life insurance is another way to finance the tax obligation.

“You can start a savings fund if you want to match the possible tax liability, or, unfortunately, you may have to pass the tax liability to the estate when you die, which can be treacherous, because if the estate does not have the funds you may be forced to sell the country house, or one of the beneficiaries may have to step up to finance the tax obligation themselves.”

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source: Canadian Real Estate Magazine