The article “Managing Tax In A “Tenancy In Common” Situation” was originally published on MoneySense on November 24th, 2020.
Claudia wants to minimize the tax payable when selling her share of a cottage to the co-owner.
Q. I am a co-owner of a cottage in Ontario. The other co-owner would like to buy out my 50% share of the cottage as tenant in common. Do I have to claim capital gains if the cottage isn’t being sold?
A. Real estate is commonly owned as joint tenants, with rights of survivorship by spouses. However, tenancy in common is another ownership option that can be suitable for certain situations.
As an example, when siblings, friends or common-law spouses own real estate, they may not want their share to go to the survivor if they die. If they own the property as tenants in common, their respective shares can go to their respective estate if they die, and can be divided among their beneficiaries rather than going to the surviving co-owner.
You ask about whether you need to claim capital gains given the property is not being sold, Claudia. However, you are selling it—just not to a third party. You are legally selling your share to the co-owner.
Even if you were to transfer your share to the co-owner without money changing hands, as one might do with a child to transfer the family cottage to them, that will not avoid a deemed disposition or sale with the sale price based on the fair market value. The fair market valuation applies even if you choose an artificially low sale price; the actual value is what Canada Revenue Agency looks at when you make a transfer or sale to a non-arm’s-length party, such as a child.
Whether or not the sale triggers a capital gain depends on the purchase price, as well as the renovations or capital improvements you’ve made during the time you have owned the property, Claudia. If the sale price is higher than the adjusted cost base, that excess will be treated as a capital gain, less any transaction costs, like legal fees.
The capital gain may be tax-free if you are able to claim the cottage as your principal residence. A cottage can qualify for the principal residence exemption but may expose another home you own to tax for the years you owned both properties. It may only be advantageous to use the principal residence exemption for your cottage if it has risen in value significantly compared to your home. This is usually not the case.
If your cottage sale to the co-owner results in a taxable capital gain, there may be some ways to lessen the tax burden.
The simplest option may be to defer the transaction to the new year. If nothing else, that pushes the tax back one year, if your co-owner is fine with delaying the transaction.
You can also have the sale taxed over multiple years. You could structure the sale so that half of your share, or 25% of the total value, is sold this year and the remainder is sold next year. That would split the gain over two years.
If the capital gain is significant, and your co-owner is agreeable, you may be able to sell the property over as many as five years. If you sell an asset, like a cottage, you can claim a capital gains reserve if the proceeds are paid over multiple years. The catch is you need to bring at least 20% into income each year, even if the proceeds are paid over a long period of time.
In the case of your cottage, you could sell your share over five years, with 20% of the proceeds payable each year. You may want to negotiate interest payable by your co-owner on the unpaid funds, similar to a mortgage or other debt, given that you lock in your price today but don’t receive all the money until a future date.
Another tax reduction strategy could be making RRSP contributions. If you have unused RRSP room, you can take advantage of the tax deduction a RRSP contribution offers. Even if you are not working, you may have leftover RRSP contribution room. If you or your spouse are under the age of 72, you can contribute to your RRSP or a spousal RRSP in your spouse’s name. If you make a large RRSP contribution with the cottage sale proceeds, the related tax deduction can help offset the income inclusion from the cottage capital gain.
Cottages often have tax implications for owners. Consider yourself fortunate that you may have some flexibility with the capital gain if your co-owner is flexible, or if you can take advantage of some of the strategies I’ve outlined above.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.