- The cottage is treated as sold at fair market value just before death, and the gain is taxed on the deceased's final return, not to the children.
- Only one property can be designated as a principal residence for each year, so the home and cottage compete for the exemption.
- A legal representative must obtain a clearance certificate before distributing property, or risk personal liability for unpaid amounts up to the value distributed.
A family cottage is often worth far more than what was paid for it decades ago. When the owner dies, children sometimes discover that the cottage can carry a large tax bill, even though no one has sold anything.
This article explains how the deemed gain works, how the exemption choice between the home and the cottage plays out, and what options exist to fund or defer the tax. Your own numbers matter a lot here, so treat it as background and talk to an accountant or lawyer.
This article covers Canadian federal tax law, which applies in every province.
Why there is tax when no one sells
On death, a taxpayer is deemed to have disposed of each capital property immediately before death for proceeds equal to its fair market value, and the tax is carried by the final return rather than by an inheritance tax.
The gain is the fair market value on the date of death minus the adjusted cost base, reported on Schedule 3 and line 12700. The deceased reports it on the final return, not the beneficiaries. The children then take the cottage at its fair market value at death as their cost.
So the children do not report the gain themselves, but the tax on the final return still has to be dealt with. To delay payment, the representative must give the CRA acceptable security and complete Form T2075, and interest still accrues.
The exemption choice between the home and the cottage
A gain on a home may be fully or partly exempt, but the property must still be reported on Schedule 3 and designated on Form T1255, and the designation covers only years up to the date of death. A cottage can qualify as well, but a second property cannot be designated for a year in which another property of the family unit is designated.
Where a family owns a home and a cottage, only one can be designated for each year, so part of the deemed gain on the other may be taxable on the final return. The gain is fully exempt only if the property was the principal residence for all years owned, or all but one, and no other property was designated for those years.
- Compare the gain on each property, since the property with the larger gain per year may benefit more from the designation.
- Count the years each property was owned and which years the family designated one or the other.
- Remember that the designation covers only years up to the date of death.
Options to defer or reduce the tax
Which options are open depends on who inherits and how the will is written. Some of the main rules are below.
| Option | How it works | Limits |
|---|---|---|
| Spouse or common-law partner rollover | The cottage passes at the deceased's adjusted cost base, and the spouse takes it at that amount | The spouse must be resident in Canada, and the property must vest within 36 months |
| Qualifying spouse trust | The rollover can apply to a trust created by the will, where the spouse gets all the income for life | The trust must be resident in Canada and no one else can get income or capital during the spouse's lifetime |
| Elect out of the rollover | The representative can choose that the rollover not apply, property by property | Proceeds are then set at fair market value |
| Delay payment | Give the CRA acceptable security and complete Form T2075 | Interest still accrues |
Some cottages are used in a farming or fishing operation, and farm or fishing property passing to a child has its own deemed-proceeds rule. Whether a recreational cottage qualifies depends on the facts, so ask before assuming it does.
There may also be other ways to spread the cost of the tax or to use the deceased's losses. Some of these depend on details that vary by situation, so confirm them with an accountant before relying on them.
Paying the tax and protecting the executor
Unpaid balances bear compound daily interest from the day after the due date, and late filing with a balance owing carries a penalty of 5% of the balance plus 1% for each full month late, up to 12 months. The penalty can be higher if a late-filing penalty was assessed in any of the 3 previous years, and the CRA may cancel penalties or interest for circumstances beyond your control.
The final return for a death from January 1 to October 31 is due April 30 of the following year. If the deceased, or the spouse or common-law partner living with them, carried on a business on the date of death, the filing due date is instead June 15 of the following year for deaths from January 1 to December 15, and the payment due date does not change. For a death from November 1 to December 31, the return is due 6 months after the date of death.
A legal representative must obtain a clearance certificate before distributing property under their control. Without it, the representative is personally liable for the unpaid amounts to the extent of the value of property distributed. It is requested on Form TX19, and the form should not be filed until the notices of assessment have been received, unless an exception applies.
A certificate does not stop the CRA from recovering unpaid tax later from an estate or beneficiaries. How the estate raises the cash, whether from other assets or from selling the cottage, depends on your situation, so it is worth confirming with a lawyer or accountant.
What to do next
- Get a date-of-death value for the cottage and keep the supporting records
- Gather the purchase price, closing costs and receipts for major improvements
- List every property owned by the family unit and which years each was designated
- Check the will for a spouse or spouse trust before deciding on the rollover
- Estimate the tax and compare it with the cash and liquid assets in the estate
- Talk to the family early about whether to keep or sell the cottage
If the estate sells the cottage after death, the gain on that sale is reported on the estate's T3 return, not on the final return. A lawyer or accountant can help you plan before the cottage is transferred or listed.
Frequently asked questions
Do the children pay tax when they inherit a cottage?
The deemed gain at death is reported by the deceased on the final return, not by the beneficiaries. The children take the cottage at its fair market value at death as their cost. They would report a gain or loss only if they later sell, based on the sale price minus that value.
Can the principal residence exemption cover both the home and the cottage?
Only one property can be designated for each year, so the home and cottage compete. Part of the gain on the other property may therefore be taxable on the final return.
Can we put off paying the tax?
To delay payment of tax on the final return, the representative must give the CRA acceptable security and complete Form T2075, and interest still accrues. Where the cottage goes to a spouse, the rollover may defer the gain itself if its conditions are met.
Should the executor wait before handing over the cottage?
Usually yes. A legal representative must obtain a clearance certificate before distributing property, or risk personal liability for unpaid amounts up to the value distributed. A new certificate is not needed before each distribution if enough property is kept back to cover any potential liability.
Sources
- Income Tax Act, s. 70 — Justice Laws (federal)
- CRA – Doing taxes for someone who died: Capital gains — canada.ca
- CRA – Doing taxes for someone who died: Capital gains / Report income — canada.ca
- CRA – Guide T4037, Capital Gains — canada.ca
- CRA – Filing and payment due dates — canada.ca
- CRA – File the returns — canada.ca
- Income Tax Act, s. 159 — Justice Laws (federal)
- CRA – IC82-6, Clearance Certificates — canada.ca
Links go to official government, court and regulator pages. The law changes — confirm you are reading the current version.
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