Taxes usually aren’t top of mind when clients buy a recreational property, even though they should be. Here are three ways to share as little as possible with the CRA.
Claim the exemption on the biggest gain
If your client lives in a recreational property part of the year, he can claim the principal residence exemption on that property. He may even be able to claim the exemption on a property outside of Canada. But there’s a catch: he can only claim the exemption on one residence at a time.
Assume he bought his house and inherited a cottage in 1999. In 2011 he decides to sell his 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, he can claim the principal residence exemption on only one of the properties. Although he doesn’t plan to sell the cottage anytime soon, it may be wiser to pay the small amount of tax on the capital gain on his house (he’ll have to pay tax on an extra $25,000 of income) and preserve the ability to claim the much larger exemption for those years on the cottage when he decides to sell.
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If he elects not to claim the exemption on the house when he sells, he needs to report the capital gain/loss on his tax return and file Form T2091-(IND), “Designation of a Property as a Principal Residence by an Individual.” If he doesn’t, CRA assumes he is using the exemption to eliminate the gain, and he won’t be able to use it for the cottage for those years.
Keep track of capital costs
Clients can minimize tax by keeping good records of the capital costs they 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 the 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 the roof was in terrible shape when your client bought the property, the cost of a new roof would be a capital expense, while replacing the roof 15 years after she bought the property with similar roofing material would not. If clients keep track of capital expenses, they’ll know whether to claim the exemption on their homes or second properties. Make sure they keep these receipts for at least three years after selling the property. Suggest they keep a folder labelled ‘home capital costs’ for these receipts.
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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 the child, he or she can’t claim the capital gains exemption. If the parents contributed money to buy it and will receive all of the sale proceeds, only they can claim the principal residence exemption. If the parents receive all of the sale proceeds and do not elect out of the principal residence exemption, they will not be able to use it on any other property they own for the same time period. Also, putting a child’s name on the title of a property can expose the property to creditors of the child (like ex-spouses).
And don’t 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 exposing the property to creditors.