With widespread lockdowns and office closures, many people had to quickly pivot from the office to working from home. This led to an influx of people looking at cottage properties as an opportunity to live and work in a more tranquil setting.
Cottage owners may find themselves contemplating more complex questions that could have significant income tax implications down the road.
Are there any income tax implications to renting out my cottage?
Yes. When you begin renting a personal property, you may have changed the use of that property for income tax purposes. This means that where you convert your cottage to a rental property, you will be deemed to have disposed of your cottage at fair market value (FMV) and tax will need to be computed on the difference between the FMV of the cottage at the time of the change in use and its adjusted cost base (ACB). Any resulting capital gain may be reduced or eliminated by using the principal residence exemption.
However, you can make an election to defer the deemed disposition on a change in use to a later year. By making this election, it may also be possible to continue to designate the property as a qualifying principal residence for up to four years, or even longer in the appropriate circumstances. There are specific guidelines for making this election and care must be taken not to inadvertently rescind it.
Am I able to claim expenses against the revenue earned?
Yes. While the revenues earned from renting your cottage will be taxable, you will be able to claim a reasonable portion of the operating expenses for the cottage, as well as costs directly associated with renting the property (such as cleaning, advertising, commissions or fees paid to rental agents, and property management fees). You may also be eligible to claim depreciation, referred to as capital cost allowance (CCA) for income tax purposes, against the rental income. You may only claim enough CCA to bring your net rental income down to zero. The ability to claim a rental loss depends on the amount of personal use and whether the rental of the property is conducted in a commercial manner.
Is the principal residence exemption available to me if we sell our cottage?
The sale of your cottage property will result in the realization of a capital gain if the value of your cottage increased while you owned it. However, the principal residence exemption may be available to reduce or eliminate the gain you realize.
As a result, depending on whether the principal residence exemption is available to shelter the gain you realize on the eventual sale of your cottage—and to what extent it is available—you may be able to dispose of your cottage tax-free.
Should we be keeping track of improvements made to the cottage?
It’s important to keep track of all these costs. What you spend on your cottage can have an impact on what you may ultimately pay in tax when you sell or dispose of it.
Determining what types of costs are capital costs, and thus added to the ACB of the property, can be confusing. Proper records include the original purchase documentation you received when you bought the cottage, plus any invoices or receipts that support subsequent renovations or improvements.
Improvements not directly related to the building
Make sure you include any improvements to the land that aren’t related to maintaining current elements. Costs can include a new septic system, a new well, a water system etc. Also, ensure that you include any improvements to the land such as correcting drainage problems, building a driveway or right of way, pathways, or fixed decks and docks.
Any change to the structure of a cottage that creates something that wasn’t present before will generally qualify as an addition to ACB. For those do-it-yourself cottagers—you can’t capitalize the imputed cost of your own labour, but you can capitalize the cost of the materials you used for the improvement.
If you own a cottage, or a vacation property in Canada, please contact me in the Huntsville office of BDO at 705-789-4469 to talk about the tax implications.
Scott Conner is an experienced tax practitioner and practical problem solver at BDO. As a partner specializing in Canadian income tax, Scott has particular specialties in private companies, planning for estates, trusts, and complex transactions. Scott works closely with his clients to understand their specific needs and adjust strategies accordingly. Scott and his team take a proactive, hands-on approach. They closely follow existing and proposed legislation to determine how it will affect individual financial goals, and provide ongoing guidance.