Got questions about capital gains tax and cottages? Here are three MoneySense reader questions answered by Certified Financial Planner Jason Heath.

Tax, probate, and the family cottage

Planning to leave the family cottage to your children? Here are practical ways to minimize capital gains tax as part of estate planning, and common misconceptions to watch for.

How capital gains tax applies to cottages

In Canada, capital gains tax generally applies to real estate unless you qualify for the principal residence exemption. That exemption can cover houses, cottages, cabins and similar properties, but only if the property is designated as your principal residence for the relevant years and wasn’t used to earn rental or business income.

Only one property per taxpayer can be designated as a principal residence in a given year. If someone owns both a house and a cottage, they must choose which property to designate for which years when reporting a sale. Choosing the cottage in some years may leave the house exposed to taxable capital gains in other years.

Qualified advice on naming beneficiaries and claiming exemptions

Cal, it sounds like the accountant’s advice was either misunderstood or incomplete. Simply adding children’s names to the title does not automatically eliminate capital gains tax on a future disposition. If the cottage is designated as the principal residence for certain years, those years may be sheltered from tax, but the rule allowing only one principal residence per year means tax consequences may shift to the other property.

For example, if a couple owned their house for 35 years and the cabin for 20 years, and they later claim the cabin as the principal residence for the year it’s sold, the house could be taxable for a portion of the years. The calculation uses years of ownership and the original cost base — it is not based on the value of the house when the cottage was bought or sold.

Principal residence election and death

You file the principal residence designation in the year a property is sold or is deemed sold (for instance, at death). If a property passes to a surviving spouse, the default tax position is a deemed rollover to the surviving spouse at the original cost base, so no immediate capital gain is triggered. Executors can elect to report a gain in the year of death, for example if the deceased’s income is low and sheltering gains would be tax-efficient.

Capital gains typically become payable when the surviving spouse later sells or transfers the property, or if the property is left to someone other than the surviving spouse.

Receipts and actions that reduce a capital gain

Keeping records matters. Save lawyer statements for purchases (showing land transfer tax, legal fees and closing costs), receipts for capital renovations and improvements, and eventual selling costs such as realtor commissions and legal fees — all of these increase the adjusted cost base and reduce the taxable capital gain.

Beneficial ownership and joint titling

When parents add children’s names to a title, legal and beneficial ownership can differ. If the arrangement reflects only joint legal title while the parents retain beneficial ownership (they pay the costs and continue to use the property), there is typically no immediate capital gain at the time of adding names. If, however, a genuine gift of part interest occurred, tax rules treat transfers to non-arm’s-length parties at fair market value, creating a deemed disposition unless sheltered by an exemption.

Does joint title avoid probate?

Adding children to title does not reliably avoid probate. If beneficial ownership hasn’t actually changed, the asset may still need to be disclosed and could be subject to estate administration tax. Anyone considering joint titling should document their intentions and get coordinated tax, legal and estate advice. Simple actions can have unintended tax and legal consequences.

How cottage renovations can reduce your capital gains

Phylis and her son built a cottage together and want to know what construction costs and equipment purchases can be claimed to reduce future capital gains when ownership transfers.

What counts toward the adjusted cost base

If you and your son own the cottage as tenants in common, each of you has a distinct share that you can leave by will. Alternatively, if ownership is joint tenancy with rights of survivorship, the surviving owner receives the deceased’s share automatically. Know how title is held to understand the estate outcome.

Capital improvements and renovations paid to third parties can be added to the property’s adjusted cost base and reduce future capital gain. Keep invoices and receipts for materials and contractor work. However, you cannot include unpaid personal labour in the cost base — only payments to third parties count.

Equipment purchases are more complex. Materials used in a DIY build can be capitalized. Heavy equipment that retains value after construction, or equipment that can be sold or repurposed, generally is not added to the cottage’s cost base as construction cost. Equipment rented or leased for construction may in some cases be eligible as a capital cost that increases the adjusted cost base — but this depends on specifics and merits professional advice.

Other practical considerations

Consider whether the cottage was actually beneficially owned by you. If you only were on title to help your son qualify for a mortgage, he may be the beneficial owner and any future gain could be his alone. Also think about estate liquidity: if a capital gain is large, your estate may need cash to pay the tax. Splitting proceeds among multiple beneficiaries means accounting for tax liabilities first.

There are historic exceptions that may apply depending on acquisition dates: prior to 1995 a lifetime capital gains exemption existed, and capital gains rules changed in earlier decades too. If the property has a long ownership history, review past elections or rules with a tax advisor to confirm treatment.

Reducing capital gains when selling a cottage to family

Fred asks whether his mother can claim her cottage as her principal residence before selling it to her children, and how to minimize tax on that sale.

Designating the principal residence and past ownership

Each Canadian taxpayer may designate one property per year as a principal residence. The property must be ordinarily inhabited by the taxpayer during the year. If your mother previously owned and designated another home as her principal residence, only the years after that sale would be available to designate the cottage as her principal residence.

For example, if she bought the cottage in 1990 but sold an earlier home in 2010, she could only designate the cottage as principal residence for 2010 onward. Years prior to the earlier sale are likely taxable when she disposes of the cottage.

Historic elections, like the lifetime capital gains exemptions available before the mid-1990s, and the fact that capital gains were taxed differently in earlier decades, can affect the calculation. Check past filings with a tax professional.

Selling to family: fair market value and timing

For tax purposes, transfers between family members are treated at fair market value. You cannot legally assign an arbitrarily low sale price to reduce capital gains; the transaction will be deemed to occur at fair market value. A gift or a low-value sale can still trigger tax based on that fair market value.

If spreading the tax burden makes sense, a sale structured with a purchase price paid over several years may permit the seller to claim a capital gains reserve, deferring portions of the gain across tax years. This can smooth tax liabilities if the gain is significant.

Non-tax considerations when transferring a cottage

Tax is only one part of the decision. Selling or transferring ownership changes who controls and uses the property. Consider who pays ongoing expenses (property tax, utilities, insurance, maintenance), how usage will be allocated between siblings, and how ownership might affect future family legal issues such as divorce or creditor claims.

Before structuring a sale or transfer to family, discuss expectations, costs and governance with all parties and get coordinated legal and tax advice so you understand the full implications.

Related topics

• Capital gains tax on the sale of property
• Capital gains tax when selling a rental property
• Capital gains tax when separating or divorcing
• Principal residence rules for seniors and other exemptions