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Is there a tax exemption for capital gains? No, but find out how to allocate your principal residence exemption and more.
How will the $200,000 tax-free capital gains affect our non-principal residence? Is each tenant entitled to $200,000? My wife and I are original owners / joint tenants of our cottage and we expect to sell before we hit the retirement home in a few years. The original building and properties costs were less than $10,000. Current assessment is $120,000. Our joint marginal tax rate is 20% and average tax rate 10%.
—Charles
Cottages can be great for unwinding and spending quality time with family. However, owning a cottage can be expensive when it comes to maintenance costs and ultimately to income tax.
Assuming you have another home that you live in, Charles, there will be tax implications from the sale of one of your two properties. You can actually claim the principal residence exemption for your cottage, making the sale tax-free without limits. But I’m guessing the capital gain on your house would be larger and more preferable to shelter from capital gains tax as your principal residence.
I gather, with the reference to a $200,000 capital gains exemption mention, that you are confused about the $100,000 lifetime capital gains exemption that applied in Canada from 1984 to 1994. During that time, each spouse could have up to $100,000 of lifetime capital gains free of tax. Some Canadians declared a deemed capital gain on their 1994 income tax return that pushed up the tax cost of certain capital assets for tax purposes—including their cottages—based on the market value at that time. You should check if you did, as this would reduce the ultimate capital gain on a sale.
However, there is currently no $200,000 capital gains exemption, Charles. And that $100,000 capital gains exemption is no longer available to claim, so you cannot make a retroactive election. The only capital gains exemptions that exist currently relate to the sale of private company shares or eligible farm or fishing properties. These exemptions are $1.25 million per spouse as of June 25, 2024, with an additional $2 million Canadian Entrepreneur’s Incentive to be phased in over 10 years between 2025 and 2034.
Given the $10,000 cost and $120,000 market value, there is a capital gain of $110,000 currently. Eligible capital expenses or renovations over the years would be added to the cost for tax purposes. Selling costs, like real estate commissions and legal fees, would be deducted from the proceeds. If we assume a net capital gain of $100,000 after transaction costs, $50,000–or one-half–is taxable in the year of sale. If a taxpayer’s capital gains exceed $250,000 in a single year, a higher two-thirds inclusion rate (66.67%) applies to the excess.
If you’re in a 20% marginal tax bracket, I’m going to make an assumption for discussion purposes that your income is $30,000 and that you live in Ontario, Charles. The taxable capital gain of $50,000 would be allocated–$25,000 each–between you and your wife. So, your taxable income would be $55,000 with a new marginal tax bracket of about 24% and average tax rate of about 15%. Depending on your sources of income and tax credits, you might incur about $5,000 of income tax each on the sale.
If you own two pieces of real estate at any given time in Canada, unless one has gone down in value from your original purchase price, you’re sitting on an eventual taxable capital gain. The exception may be for a farm or fishing property, but specific criteria apply. The income inclusion is reduced somewhat given that only half of a capital gain is taxable unless your annual capital gains exceed $250,000. It’s important to plan for eventual taxation of all of your property–whether on sale or on death.
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So you own a cottage (or any other second home or condo, for that matter); what is preventing this person from selling their primary residence without capital gains, move into the cottage or any other second home for a period of a few years and then sell the second property – would that be subject to capital gains?
Thank you,
Paul