Changes to Canada’s Capital Gains Tax spell trouble in Ontario cottage country

On April 17, Finance Minister Chrystia Freeland unveiled the 2024 federal budget, sparking significant interest among property owners, particularly cottage owners, Canada-wide. A key proposal within the budget is the introduction of the new capital gains tax on cottages, particularly the increase in the inclusion rate for gains exceeding $250,000. This change to the capital gains tax spells significant trouble for Ontario cottage country and cottage owners across Canada.

Currently, Canadians are taxed on 50 percent of capital gains realized from the sale or gift of a property. For instance, if a cottage was sold for $900,000 after being purchased for $100,000, the taxpayer would be liable for taxes on $400,000, or half of the $800,000 capital gain. This amount would be added to the individual’s income and taxed at their marginal tax rate.

What Are Capital Gains?

In Canada, capital gains tax is a tax on the profit realized from the sale or disposition of certain types of assets, known as capital assets. Capital assets can include real estate properties such as cottages, stocks, bonds, mutual funds, and other investments.

When a capital asset is sold for more than its original purchase price, the difference between the sale price and the purchase price is considered a capital gain. Canada Revenue Agency (CRA) taxes 50% of this capital gain at an individual’s marginal tax rate, which means that only half of the capital gain is included in the individual’s taxable income for the year of the sale. This is commonly referred to as the “inclusion rate.”

The capital gains tax rate is based on an individual’s total taxable income, which includes both regular income and the taxable portion of capital gains. For example, if an individual’s marginal tax rate is 30% and they realize a $100,000 capital gain, only $50,000 of the gain would be included in their taxable income.

Certain types of capital gains may qualify for special treatment or exemptions. For instance, capital gains realized on the sale of a principal residence may be eligible for the principal residence exemption, which allows individuals to shelter all or a portion of the gain from taxation.

It’s important for taxpayers to understand the rules and regulations surrounding capital gains tax in Canada and to consult with tax professionals or financial advisors to ensure compliance and optimize tax planning strategies.

How the new inclusion rate will affect Ontario cottage owners

Effective June 25, 2024, the proposed change would increase the inclusion rate to two-thirds (approximately 66.7 percent) for capital gains exceeding $250,000. Gains below the $250,000 threshold would still be subject to the 50 percent rate. Therefore, if a cottage sale resulted in an $800,000 profit, the individual would be taxed at 50 percent on the first $250,000 ($125,000) and approximately 66.7 percent on the remaining $550,000 ($366,666). This would bring the total taxable amount to $491,666, representing nearly a 23 percent increase.

Strategic decisions are necessary for Ontario cottage owners

For cottage owners facing this change, strategic decisions are necessary. Peter Lillico, a lawyer and cottage succession expert, advises those considering passing down their property to act before the June 25 deadline to take advantage of the current capital gains rates. Alternatively, transforming the cottage into a principal residence may offer tax benefits, as principal residences remain exempt from capital gains taxation. However, this decision hinges on factors such as usage and occupancy.

Impact will be broader particularly for cottage owners

Mike Tranter, a financial planner, suggests that for those with multiple properties, electing the principal residence exemption on the cottage with the larger capital gain may be advantageous at the time of sale.

Despite government claims that only a small percentage of Canadians with high incomes will be affected, Lillico argues that the impact will be broader, particularly for cottage owners. He emphasizes that the tax increase will directly impact cottagers, who often retain capital gains within the property until passing it on to heirs.

Cottagers face the prospect of increased capital gains taxes to maintain ownership within the family. As Lillico asserts, this change will have significant implications for cottage owners moving forward.

Why Was the $250,000 Threshold Chosen for Individuals?

Based on federal government data, it’s estimated that 28.5 million Canadians will not have any capital gains income, while three million individuals are projected to earn capital gains below the $250,000 annual limit. Additionally, the data shows that only 0.13 percent of Canadians—those with an average income of approximately $1.4 million per year—are expected to experience an increase in personal income tax due to the proposed change.

AVOIDING CAPITAL GAINS TAX when selling a cottage

Avoiding capital gains tax when selling a cottage requires careful planning and consideration of various strategies. Here are some approaches to potentially minimize or eliminate this tax burden:

1. Take Advantage of Principal Residence Exemption: If the cottage qualifies as your principal residence, you may be able to claim the principal residence exemption, which exempts the property from capital gains tax. To do this, you must ensure that you or your family have used or occupied the cottage during each tax year you’re claiming the exemption for.
2. Plan for Timing: Selling the cottage before the proposed changes take effect on June 25, 2024, can help you avoid the increased capital gains tax rate. If selling isn’t immediately feasible, consider accelerating plans to sell before the deadline.
3. Gift the Cottage: Transferring ownership of the cottage to family members as a gift rather than selling it can potentially avoid capital gains tax. However, gifting may have other tax implications and requires careful consideration.
4. Utilize Tax-Free Accounts: Depending on your circumstances, you may be able to utilize tax-free accounts such as a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP) to shelter capital gains from taxation.
5. Seek Professional Advice: Consulting with tax professionals, financial advisors, or estate planning experts can help you develop a personalized strategy to minimize capital gains tax while maximizing financial benefits.
6. Consider Partial Sale: If selling the entire property would result in significant capital gains tax, consider selling only a portion of the cottage or subdividing the property to reduce the taxable gain.
7. Invest in Renovations or Improvements: Investing in renovations or improvements that increase the property’s cost base can potentially reduce the taxable capital gain when the cottage is sold.
8. Explore Trusts or Holding Structures: Establishing trusts or holding structures for the cottage ownership may offer tax planning benefits, although these strategies can be complex and should be implemented with professional guidance.
9. Offset Gains with Losses: If you have incurred capital losses from other investments, consider utilizing these losses to offset the capital gains realized from the sale of the cottage, thereby reducing your overall tax liability.

It’s essential to carefully evaluate the potential tax implications and consult with tax professionals or financial advisors to determine the most suitable strategy for your specific circumstances.

Final Thoughts

The introduction of the new capital gains tax on cottages, particularly the increase in the inclusion rate for gains exceeding $250,000, has significant implications for cottage owners across Canada. While the government aims to target only a small percentage of high-income individuals, the reality is that many cottage owners may find themselves affected by the change.

Strategic planning and consideration of options such as using the principal residence exemption or gifting properties may be necessary to mitigate the tax increase’s impact. Ultimately, the new tax regime underscores the importance of staying informed and seeking professional advice to navigate the evolving landscape of property taxation and estate planning, ensuring that cottage owners can preserve their assets and financial legacies for future generations.

by Myles Shane

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