Tax tips for your cottage

When you decide to buy a new cottage, it’s location, transit, amenities, and, yes, money on your mind. But you should also be looking past the initial price and considering how a cottage can help — and hurt — your taxes.

Although you can’t avoid sharing your money with the Canadian Revenue Agency (CRA), there are a few key ways you can use your cottage to minimize their cut.

1. Claim the exemption on the biggest gain

If you live in a recreational property part of the year, you can claim the principal residence exemption on that property, but you can only claim the exemption on one residence at a time.

Let’s say you bought your house and inherited a cottage in 1999, then in 2011 decide to sell your house and move to a new one, while keeping the cottage. Assume during this period the house appreciated in value by $50,000, and the cottage by $225,000.

For the years 1999 to 2011, you can claim the principal residence exemption on only one of the properties. Although you don’t plan on selling the cottage anytime soon, it may be wiser to pay the small amount of tax on the capital gain on your house to preserve the ability to claim the much larger exemption when you decide to sell the cottage.

Just don’t forget to indicate to CRA that you’re paying the tax, because the assumption will otherwise be that you’re using the exemption.

2. Keep track of capital costs

You can also minimize tax by keeping good records of the capital costs you put into cottages. Any capital expenditures will reduce the amount of capital gain later. That’s because technically the gain is the difference between the “proceeds of disposition” (usually sale proceeds) and the “adjusted cost base” (purchase cost plus capital costs).

A capital cost means it’s for a lasting improvement to the original condition of your property, which is its condition when purchased. If the expense represents something that is used up or is replacing something that was used up, it isn’t a capital cost. Utility bills or replacing worn-out carpet are not capital expenses. Adding carpet to a floor that was never carpeted would, however, be a lasting improvement to the property’s original condition.

If your roof was in terrible shape when you bought the property, the cost of a new roof would be a capital expense, while replacing the roof 15 years after you bought the property would not.

Make sure you keep all receipts for at least three years after selling your property.

3. Plan carefully

Don’t put an adult child on the title of a residence purchased for him to live in while he attends school. Unless the house is gifted to your child, he or she can’t claim the capital gains exemption.

If you contributed money to buy it and will receive all of the sale proceeds, only you can claim the principal residence exemption. If you receive all of the sale proceeds and do not elect out of the principal residence exemption, you won’t be able to use it on any other property you own for the same time period. Also, putting your child’s name on the title of a property exposes the property to their creditors.

It’s also a bad idea to add an adult child to a title to avoid probate tax on death. You may end up triggering capital gains, setting the stage for an estate dispute, or, again, exposing the property to creditors.

Yens Pedersen is a lawyer in Miller Thomson LLP’s Regina office specializing in estate planning, wills and tax audits.