Sell Your Cottage Tax-Free: What You Need to Know

Ask MoneySense

How will the $200,000 tax-free capital gains affect our non-principal residence? Is each tenant entitled to $200,000? My wife and I are original owners / joint tenants of our cottage and we expect to sell before we hit the retirement home in a few years. The original building and properties costs were less than $10,000. Current assessment is $120,000. Our joint marginal tax rate is 20% and average tax rate 10%.

—Charles

Can you avoid capital gains on a cottage?

Cottages are a wonderful place to relax and make memories, but they can also create a tax liability when you sell. If you and your spouse own two properties and live in one full-time, selling the second property — the cottage — will usually trigger a capital gain unless you can designate it as your principal residence for the years in question.

You can designate one property as your principal residence for the years you ordinarily lived in it and meet the relevant conditions. If you successfully designate the cottage as your principal residence for all years of ownership, the gain on sale can be sheltered from tax. In many cases, though, homeowners prefer to designate their primary home as the principal residence if that sheltering yields a larger tax benefit. This decision depends on the relative gains on each property over the period of ownership.

Is there a capital gains tax exemption?

There is no current general $200,000 capital gains exemption for personal properties such as cottages. The reference you mentioned to a $200,000 figure likely stems from an older rule: between 1984 and 1994 Canada allowed a lifetime capital gains exemption of $100,000 per spouse. Some taxpayers used a deemed disposition election in 1994 that established a new tax cost base for certain properties at that time, which can reduce the capital gain when those properties are later sold. If you made such an election back then, it would affect the calculation now, so it’s worth checking your tax records.

Today, the available lifetime exemptions relate primarily to qualifying small business shares and certain farm or fishing properties. As noted in recent years, those exemptions are significantly larger (for example, amounts in the millions per spouse for eligible business dispositions), but they do not apply to a typical cottage sale.

How capital gains are calculated and how to reduce tax

Using the figures you provided: an original cost of under $10,000 and a current value around $120,000 implies an unadjusted capital gain of roughly $110,000. For tax purposes you determine the adjusted cost base (ACB) by adding eligible improvements and capital expenses you have kept records of. Selling costs such as real estate commissions and legal fees are deductible from the sale proceeds. After those adjustments, the taxable portion is normally one-half of the capital gain.

For example, if transaction costs and documented improvements reduce the net capital gain to about $100,000, then $50,000 would be included in taxable income under the usual 50% inclusion rate. There is a separate rule for very large capital gains: when a taxpayer’s annual realized capital gains exceed $250,000, a higher inclusion rate (66.67%) applies to the excess amount.

In joint ownership situations like yours, the taxable capital gain is typically split between owners according to their ownership shares. As joint tenants, many couples split gains equally, which means each spouse would include half of the taxable capital gain on their return unless a different allocation is supported by agreements or circumstances.

A rough example of potential tax impact

To give a rough idea: if the net taxable capital gain is $50,000 and you split that equally, each spouse would include $25,000 in income. If your household income before the sale is modest and your marginal tax rate is around 20%, the sale could increase your taxable income and push you into a slightly higher marginal bracket for the year. That could mean an additional tax bill for each spouse — perhaps in the low thousands — depending on exact income, credits and deductions. Exact amounts will vary by province and by your full income picture.

Practical steps and planning tips

To minimize the tax bite and avoid surprises, consider these practical steps:

Gather records of any capital improvements you made over the years (roof, dock, major renovations) to increase the adjusted cost base.
Keep invoices for selling expenses (commissions, legal fees) to reduce your proceeds on the sale.
Confirm whether any past election or deemed disposition (for example, in 1994) affects your cost base.
Consider timing the sale in a year when your other income is lower so the added taxable gain is taxed at a lower marginal rate.
Discuss options with a tax professional to confirm ownership allocation, proper reporting and any planning opportunities that fit your situation.

In short, there’s no automatic $200,000 personal exemption available for cottage sales today, and any taxable gain will normally be reported and taxed based on the adjusted cost base, selling expenses and the inclusion rate rules. Careful record-keeping and a little planning can meaningfully reduce the tax owing when you sell.