Sell a Cottage to a Family Member: Capital Gains Tax

What happens when you sell your cottage to a family member

The family cottage often carries strong emotional value, but when ownership changes hands—especially within a family—tax consequences can follow. In your situation, Terry, you’ve already sold your one-half interest in the cottage to your niece. The main question now is whether that sale produces a taxable capital gain and, if so, how to calculate it.

Can a family cottage be exempt from capital gains?

It depends on the circumstances. A capital gain arises when you dispose of an asset for more than its tax cost. In Canada, capital gains have been taxable since 1972, but certain disposals and assets can be exempt. Among common exemptions are gains from an eligible principal residence and some gains tied to specific farm, fishing or small business property limits. Investments in registered accounts such as RRSPs, TFSAs and RESPs are also sheltered from immediate capital gains tax. Whether any of these exemptions apply to your cottage sale depends on how the property was used and what designations you or your family claimed during ownership.

Can you claim principal residence for a cottage?

A cottage can qualify as a principal residence if it meets the Canada Revenue Agency’s tests and you designate it as such for the years in question. Each taxpayer (or, since 1982, a family unit) can designate only one property per year as their principal residence for the purpose of excluding capital gains. If you and your spouse designated the cottage as your principal residence for some or all years you owned it, you may be able to claim an exemption for those years and reduce or eliminate the taxable gain on the sale of your share.

When it may not be wise to claim the cottage as a principal residence

Claiming the cottage as your principal residence isn’t always the best choice. Because only one property per family unit can be designated in a given year, using that designation for a cottage can affect the exemption available when you later sell your primary home. For example, if you designate the cottage as your principal residence for 20 years and you later sell your house after owning it for 40 years, half of the house’s gain may become taxable because the cottage was designated for 20 of those years. If the expected tax on your house would be greater than the tax saved on the cottage sale, you might choose not to designate the cottage as a principal residence.

Do capital gains taxes apply to property sales between family members?

Yes. Disposing of appreciated property to a family member—whether by sale or gift—typically triggers a deemed disposition at fair market value, which can create a capital gain. Trying to use an artificially low sale price or a below-market gift to avoid tax is generally ineffective because transactions between related parties are usually treated at fair market value for tax purposes. One common exception concerns transfers between spouses, which are usually made at the transferor’s original cost for tax purposes, unless an election is made to transfer at a different value. Income or gains from such transfers can still be attributed back to the transferor in specific situations, except where the transfer occurs on death.

How to determine the ACB for a cottage

To calculate the ACB for your half of the cottage, start with what you originally paid for that share. If you acquired the property before 1972, the relevant cost for tax purposes is often treated as the fair market value in 1972, because that is when capital gains became taxable. Additionally, taxpayers who owned property before 1994 may have made elections under the pre-1994 rules that affect the ACB—some owners used the then-current fair market value as a deemed cost for a limited lifetime exemption available at the time. Any such election you previously made will influence the ACB today.

How inheritance affects the ACB

If you inherited your interest in the cottage, the usual rule is that the cost for tax purposes becomes the fair market value at the date of the deceased’s death. That stepped-up cost typically reduces or eliminates a capital gain on a later sale compared with the original purchase price paid by the deceased.

What acquisition and selling costs can reduce your capital gain?

Certain costs associated with buying and selling the property can be added to the ACB or deducted from proceeds to reduce a capital gain. Typical deductible costs include land transfer taxes, legal fees, real estate commissions and fees directly tied to the acquisition or disposition. In addition, capital improvements to the property—such as a new roof, dock, deck or other renovations that add enduring value—are added to your ACB and therefore help lower the taxable gain when you sell.

Practical next steps when selling a cottage

Selling a cottage, even to a family member, raises several tax considerations. You’ll need to confirm the correct ACB, check whether a principal residence designation applies or is advisable, and total allowable acquisition and selling expenses. Because these calculations can affect your tax bill now and in the future, it’s wise to gather your purchase records, receipts for capital work and legal or real estate invoices. If the numbers are complex or the potential tax implications are significant, consult a tax professional to review your situation and recommend the best approach.

Read more about owning a cottage:

• Tax deductible expenses when selling a cottage in Canada
• Is a vacation home a good investment?
• How cottage renovations can reduce your capital gains
• Family legacy: How to pass along the family cottage—and three pitfalls to avoid