The article “How Cottage Renos Can Reduce Your Capital Gains” was originally published on MoneySense on June 12, 2018.
Phylis and her son own a cottage together. She wants to understand the future tax and estate planning implications.
Q: My son and I have purchased property and built a cottage. I am now going to will my share to him. We have done the majority of work ourselves but purchased some equipment to help us. Ie. excavator, skidster, and my son also built a barge because the property is only water access. Can we claim any of this equipment when calculating out the adjusted cost of the cottage?
A: You’ve raised a number of different points, Phylis.
You mention willing your share of the cottage to your son. I suspect that may mean you both own your shares as tenants in common, meaning your 50% interests are separate and distinct and can be dealt with separately – including in your wills.
If so, you certainly can designate your share of the cottage to go to your son in your will.
I find people are often confused with joint ownership though. If your ownership was actually established as joint tenants with rights of survivorship, your share would pass to your son directly on your death (and vice versa) and would not pass through your will at all. So make sure you know how the ownership was established initially, Phylis, so you understand the estate implications.
You could consider changing ownership from tenants in common to joint tenants if you both wanted the property to go to each other on death, though your son may have other beneficiaries like a spouse or his children who he wants his share to go to instead. Joint tenancy may help you reduce or avoid having to pay probate fees to your province of residence to settle your estate on your death. Depending on your province of residence and the cottage value, probate could be thousands of dollars.
When a taxpayer owns multiple properties, like a house and a cottage, only one can be designated as her or his principal residence in a given year. When you sell a property – or when you’re deemed to have sold, on your death – that’s the point at which you make a designation as to whether some or all years of ownership are tax-free as a principal residence.
People’s homes tend to be more valuable than their cottages, in which case the cottage capital gain is often deemed to be a taxable capital gain, with a home being their principal residence.
There are other considerations if you owned the cottage prior to February 1994. There was a $100,000 lifetime capital gains exemption until that time, and you may have claimed a deemed capital gain to bump up your cottage adjusted cost base. And if you owned prior to 1972, there was no capital gains tax before January 1, 1972 and some of your cottage capital gain may be exempt from tax.
Assuming you and your son, Phylis, will have capital gains tax to pay on the cottage, the construction, capital improvements and renovations you did may reduce the future tax payable by increasing the cost base and reducing the capital gain. It’s important to keep proper records to support a claim. It’s also important to note that if you do work yourself on a cottage, you can’t put a value on your labour – you can only add labour paid to a third party to the cost base for capital gains tax purposes.
There’s another important point with respect to the excavator, skidster and barge. You can generally only capitalize the cost of materials for a do-it-yourself cottage build. Equipment you purchase has a value after the construction is done and could be sold. The cost of equipment you rent or lease during construction may be an eligible capital cost.
There are a few other considerations, Phylis. Assuming the property was beneficially half yours, and that you and your son contributed equally to the purchase and construction, you would have a capital gain on your death (as long as the cottage wasn’t considered your principal residence). If you were just on the property so your son could qualify for a mortgage and it was beneficially his, you may not have to claim a capital gain.
Another consideration is ensuring there is enough liquidity in your estate to pay the capital gains tax. If you have other children or other beneficiaries, just make sure you take into account how much tax will be payable on the cottage and what that means for the remaining net estate value to be divvied up amongst others if applicable.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.