Will the estate owe capital gains tax if it sells a cottage in Ontario?

Generally, yes. When a person dies owning a cottage in Ontario, the deemed disposition rules treat the deceased as having sold the cottage at fair market value immediately before death. If the cottage increased in value since it was acquired, a capital gain is realized and must be reported on the deceased's final T1 tax return.

The principal residence exemption may be available to shelter some or all of the gain if the cottage qualifies as the deceased's principal residence for some or all of the years of ownership. However, most Canadians designate their primary home as their principal residence, leaving the cottage fully exposed to capital gains. A family can designate only one property per year as a principal residence, so careful planning matters.

If the cottage was owned jointly with a surviving spouse, the deceased's half can roll over to the surviving spouse at its adjusted cost base, deferring the capital gain until the spouse later disposes of their interest. The estate's accountant and lawyer should work together on the tax treatment of real estate assets.