Will cottage fixer-upper attract tax at sale?

Cabin may qualify as a principal residence even if you don’t principally live there

Victoria Day weekend marked the beginning of cottage season for many Canadians. One of the most common tax questions vacation property owners ask this time of year is what happens if I were to sell the property — would I have to pay tax?

Around this time last year, the Canada Revenue Agency issued a technical interpretation letter in response to a taxpayer who asked whether a capital gain on the sale of his cabin could somehow be sheltered from tax.

The taxpayer, in his letter, explained that when he bought the cabin, it was “in very poor condition” and the taxpayer had to invest money to make the property livable. The taxpayer specifically wondered whether any exemption could apply to eliminate the potential capital gain that may arise when he sold it.

The CRA went through the tax rules governing the ownership, and subsequent sale, of personal-use property, which refers to items that you own primarily for your own (or your family’s) personal use or enjoyment. It includes all personal and household items, like furniture, cars, boats and recreational real estate.

In order to properly calculate any tax owing on the sale of your cottage, you take the proceeds of disposition from the sale, less any outlays and expenses incurred by you to sell the property (such as real estate commissions) and deduct from this your “adjusted cost base” (ACB), or tax cost, of the property.

The ACB is usually the amount you paid for the property, but it can include any capital expenditures you incurred, such as the cost of additions and major improvements. Normal repairs and maintenance expenses cannot not be added to the ACB.

Your capital gain or loss is then calculated by subtracting ACB from the proceeds less any outlays or expenses. You then pay tax at your marginal tax rate on 50 per cent of the capital gain unless the property qualifies for the principal residence exemption.

Yes, that’s right: Your cottage may qualify as your principal residence even if you don’t principally live there.

Under the Tax Act, in order for a property to qualify as your principal residence for a particular tax year, four criteria must be satisfied: the property must be a housing unit, you must own the property (either alone or jointly with someone else), you or your spouse or kids must “ordinarily inhabit” the property, and you must “designate” the property as a principal residence.