Cottage Sales in Ontario: Capital Gains and Which Home to Designate

Many Ontario families own a home in the city and a cottage. When one of them is sold, the question is which one to treat as the principal residence, since only one can be designated for any given year.

This article explains the rule, how the exemption formula works, and what to think about when planning. The best choice depends on figures that only you and your accountant can see, so treat this as a guide to the questions to ask.

One home per family, per year

For 1982 and later years, a family can designate only one home as its principal residence for each year. This is the key limit when a family owns both a city home and a cottage. Under the pre-1982 rules, a family could designate more than one home per year, and common-law partners could designate different homes from 1982 to 1992.

There is an exception for separated spouses. A spouse or common-law partner is not part of your family unit if, throughout the year, they lived apart from you and were separated under a judicial separation or a written separation agreement.

Can a cottage be a principal residence?

Yes. A principal residence can be a house, cottage, condominium, apartment, trailer, mobile home or houseboat. A home can still be ordinarily inhabited if you live in it for only a short time in the year, so a seasonal cottage can qualify. To count for a year, the property must meet all the conditions: it is a housing unit, you own it alone or jointly, you or certain family members lived in it at some time during the year, and you designate it.

Two limits are worth knowing. The land that counts is usually limited to half a hectare (1.24 acres), and more can count only if you show it is needed to use and enjoy the home. And if the main reason for owning a unit is to earn income, it is generally not treated as ordinarily inhabited when you live in it for only a short time in the year.

How the exemption works when you own two properties

If the home was not your principal residence for every year you owned it, only part of the gain is exempt. The exempt part is the gain × (designated years + 1) ÷ years owned. The CRA's example is $50,000 × (8 ÷ 10) = $40,000 exempt.

The 'plus 1' rule lets you treat both the home you sold and the home you bought as eligible in the year you change homes. You must be resident in Canada during the year you buy the new principal residence. If you were not resident in Canada for some years, those years do not count as designated years, but they still count as years owned.

Because each year can go to only one property, designating the city home for a year takes that year away from the cottage, and the reverse. The planning question is usually which property has the larger gain per year of ownership. Your accountant can run the numbers for each option before you sell either one.

If you rent the cottage or change how it is used

Every time you change the use of a property, you are treated as having sold it at fair market value and bought it back at the same amount. When you turn a principal residence into a rental, you can elect not to be treated as having changed its use. While the election is in effect, you can designate the home for up to four years, and you cannot claim CCA on it. The election is made by attaching a signed letter to your return for the year of the change.

If a rental is converted back to your home, a separate election under subsection 45(3) can postpone reporting the deemed sale until you actually sell. These elections have strict conditions, so get advice before you change how the property is used.

If you only rent out a small part of the property, with no structural change and no CCA claimed, the CRA generally keeps full principal residence treatment.

What to do next

• Write down the purchase date and cost of each property, and the cost of major improvements.
• List the years each property was used by your family.
• Ask your accountant to compare the gain per year of ownership on each property.
• Check whether either property was ever rented, or whether any spouse or partner lived apart under a separation agreement.
• Plan the designation before you list. On the sale, the designation is made on Form T2091(IND) with Schedule 3.
• If a designation was missed, ask promptly, since a late designation can carry a penalty.

Frequently asked questions