Selling a Cottage in Ontario: Capital Gains and Principal Residence

Many Ontario families own a cottage for decades, and its value may have risen well beyond what was paid. When it is time to sell, the main tax question is how much of the gain is taxable. For some owners the principal residence exemption can reduce or remove the gain, but only if the rules are met and the sale is reported properly.

This article explains how the designation works when you also own a home, what has to be reported, and what to do before closing. It is general information. Your accountant should run the numbers, and a lawyer can help with the sale and any estate or family issues.

How a cottage sale is taxed

When you sell property for more than you paid, the increase is a capital gain. How much of that gain is taxable depends on the current rules and your situation, so it is worth confirming with an accountant or the CRA. The principal residence exemption can shelter some or all of it. Confirm the current inclusion rate and your calculation with an accountant or the CRA rather than relying on older figures you may have heard.

The lifetime capital gains exemption sometimes mentioned in the news is a different tool. It applies to qualified farm or fishing property, which covers real property or a fishing vessel used in a farming or fishing business in Canada, along with certain shares, partnership interests and quota. A cottage used for recreation does not usually fit that description, so for most cottage owners the principal residence designation is the relevant exemption.

When a cottage counts as a principal residence

For each year, only one property can be designated per family unit. A property qualifies only if it was ordinarily inhabited in the year by the owner, spouse or common-law partner, former spouse or common-law partner, or a child, and it has been designated for that year.

That is why a family with both a city home and a cottage has a choice to make. You cannot designate both for the same year. Often the designation is spread over the years so the property with the larger gain per year gets the benefit, but the best split depends on the numbers. An accountant can compare the options.

The land also has limits. A principal residence includes the land under the housing unit plus adjoining land that contributes to its use and enjoyment as a residence. If that land exceeds 1/2 hectare, the excess is excluded unless the taxpayer shows it was necessary for use and enjoyment of the home. Large rural or waterfront lots are therefore a common issue.

What you must report

Sales of a principal residence, including a cottage, on or after January 1, 2016 must be reported on Schedule 3 of the T1 return even when the whole gain is exempt. The report gives the acquisition date, proceeds and a description of the property.

For sales in 2016 or later, CRA allows the principal residence exemption only if the sale and designation are reported on the return. The late-designation penalty is the lesser of $8,000 or $100 for each complete month from the original due date to the date of the request.

Special situations to watch

• Inherited or jointly owned cottages: each owner's share and the years of ordinary use should be reviewed, since the designation rules look to the owner, spouse, former spouse or child inhabiting the property.
• Large lots: land beyond 1/2 hectare may be excluded unless you can show it was necessary for the use and enjoyment of the home.
• Farm-related property: if land with a home is part of a farm, there are separate methods for splitting the gain between the home and farm property.
• Related investment income or losses: for farm exemption claims, a farmer with investment income or expenses since 1988 needs Form T936 for the cumulative net investment loss calculation, which can reduce the deduction.

If the cottage is owned by a corporation or trust, or if you have used part of it to earn rental income, the answer can change. Those cases are worth discussing with an accountant before you list the property.

What to do before closing

Decisions about the designation are easier before the sale than after. Start early, gather your records, and have your accountant model the options.

• Find the purchase price, closing costs, and receipts for major improvements, since they affect the calculation.
• Write down the years you or your family ordinarily inhabited the cottage and your city home.
• Ask your accountant which property to designate for which years, remembering only one per year per family unit.
• Check the lot size against the 1/2 hectare guideline and note anything that supports the need for extra land.
• Plan to report the sale on Schedule 3 and complete Form T2091(IND) if needed.
• Tell your lawyer if the cottage is held jointly, in an estate or in a trust so the sale and the tax reporting line up.
• If you forgot to report a past sale, speak to an accountant about asking CRA to amend the return and the penalty.

Frequently asked questions