Keeping good records saves tax

The cottage is our escape to peace and tranquility and the call of the loons. Unfortunately, the tax man is always around the corner! Hopefully, while you enjoy your cottage it will also substantially increase in value. When you buy a cottage, it is important to understand that you are purchasing a capital property. You may be paying capital gains tax on any appreciation in value above your cost base when you dispose of your cottage or upon your death. The Income Tax Act (Canada) deems you to dispose of all your property on death at fair market value except on a transfer to a spouse. Cottagers who do not keep good records will pay more capital gains tax than those who have kept receipts to prove to CRA their adjusted cost base (“ACB”).

What is cost base (ACB)?

Cost base is what you initially paid for the property plus all capital improvements supported by invoices and proof of payment. Improvements that are affixed to the property which have increased the value of the property will qualify as capital improvements.

Initial cost base:

  • The purchase price (if gifted or inherited, the fair market value at the time you acquired it)
  • Real estate commissions & legal fees
  • Inspection costs
  • Survey and/or title insurance costs
  • Land transfer tax

Capital enhancements:

  1. A. Improvements to land: driveway, water drainage system, septic system, well, landscaping, hydro, plumbing, geothermal, out buildings, bunkies, hot tubs, railways, decks, boathouses, docks and items affixed to docks (as long as it’s affixed to the property – a floating raft likely would not qualify)
  2. B. External cottage improvements: doors, windows, shingles, siding, expansions, new rooms, bringing hydro to property including underwater cables, attached decks, sunrooms, etc.
  3. C. Interior cottage improvements: new floors, cupboards, ceilings, kitchen upgrades, sinks, plumbing and electrical system upgrades, replacing fixtures (anything that’s attached to the house), adding walls or partitions within the cottage, bathrooms including fixtures.

Other additions to cost base:

  • The value of the cottage Dec. 31, 1971 if owned prior thereto
  • The bump by electing the $100,000 Capital Gains Exemption in 1994

Ongoing maintenance or a capital improvement – a puzzle [NTD: insert puzzle pieces]

Normal repairs, appliances and furnishings, area rugs, boats, toys, regular maintenance like opening and closing the cottage, are current expenses and don’t add to your cost base. For the do-it-yourselfer cottagers, your “Sweat Equity” also does not increase your cost base, but the cost of materials do. If you hire someone to make capital improvements that labour will qualify (any “cash” transactions don’t qualify). While it is not always clear whether certain expenses are capital in nature, a good rule of thumb is to keep all your receipts and proof of payment. Your accountant can assess whether those expenses will add to your cost base when you sell or die.

CRA auditors are increasingly requiring proper documentation to support your ACB. This includes offers of purchase or sale, appraisal for a gift or inheritance or 1971 value, invoices and receipts for all capital improvements. Make sure your file is complete. It will reduce your stress if you are audited or receive an information request.

In some cases, you may want to use your principal residence exemption on the sale, or deemed sale, of your cottage. Spouses are only entitled to one principal residence per couple since 1982. You will always want to calculate your cost base and the fair market value of all the properties that could qualify for the principal residence exemption before disposing of ANY of these properties. Cottages are frequently owned by multiple family members; a fractional interest makes use of the principal residence exemption less attractive. You should consult with a lawyer and accountant knowledgeable in this area before deciding which property to designate as your principal residence (reporting the sale is now required) and filing your tax return in the year of sale of your cottage.

The purpose of this article is for general education and interest of property owners. For questions relating to this article or for advice specific to your situation, please contact the experienced team at PKF Lawyers.