With widespread lockdowns and office closures, many people have had to quickly switch from the office to work from home. This led to an influx of people who viewed cottages as a way to live and work in a quieter environment.
Cottage owners may ask themselves more complex questions that could have a significant impact on income tax in the future.
Will renting out my holiday home have any impact on income tax?
Yes. By the time you start renting a private property, you may have changed the use of that property for income tax purposes. This means that if you are converting your vacation home into a rental property, you have sold your vacation home at fair market value (FMV) and the tax must be calculated on the difference between the FMV of the vacation home at the time of purchase, the change in use and its adjusted cost base ( ACB). The resulting capital gain can be reduced or eliminated by applying the main residence exemption.
However, you can choose whether you want to postpone the accepted disposition to a later year via a change of use. This choice also makes it possible to designate the property as a qualifying main residence for up to four years, or longer under appropriate circumstances. Special guidelines apply to making this election and care must be taken not to accidentally undo it.
Can I claim expenses against the income generated?
Yes. While the income from renting your vacation home is taxable, you can claim a reasonable portion of the operating costs for the vacation home as well as the costs directly associated with renting the property (such as cleaning, advertising, commissions or fees paid to landlords and property management fees). You may also be entitled to a depreciation, known as the Cost of Capital Allowance (CCA) for income tax purposes, on rental income. You can only claim enough CCA to reduce your net rental income to zero. The assertion of a loss of rent depends on the extent to which the owner uses the property and whether the property is rented commercially.
Will I have the main residence exemption if we sell our vacation home?
Selling your vacation home will result in realizing a capital gain if the value of your vacation home has increased while you owned it. However, the primary residence exemption may be available to reduce or eliminate the profit you made.
Depending on whether the main residence exemption exists to secure the profit you will make from the eventual sale of your holiday home – and to what extent – you can sell your holiday home tax-free.
Should we keep an eye on improvements to the cabin?
It is important to keep track of all of these costs. What you spend on your vacation home can have an impact on what tax you ultimately have to pay if you sell or dispose of it.
It can be confusing to determine what types of costs are a cost of capital and thus add to the property’s ACB. Proper records include the original purchase documents that you received when you purchased the cottage, as well as any invoices or receipts showing any subsequent renovations or improvements.
Improvements not directly related to the building
Make sure you include any improvements to the land that are not related to the preservation of the current elements. The cost could include a new sewage treatment plant, well, water system, etc. Also, make sure you include any improvements to the land such as:
Any change to the structure of a cottage that creates something that wasn’t there before is generally considered an addition to ACB. For these do-it-yourselfers: you cannot capitalize the imputed cost of your own work, but you can capitalize the cost of the materials you used for the improvement.
If you own a cottage or vacation home in Canada, please contact me at the BDO Huntsville office at 705-789-4469 to discuss the tax implications.
Scott Conner, CPA CA
Tax partner at BDO Canada LLP
Scott Conner is an experienced tax advisor and practical problem solver at BDO. As a Canadian Income Tax Partner, Scott has particular expertise in private business, estate planning, trusts and complex transactions. Scott works closely with clients to understand their specific needs and tailor 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 each financial objective and provide ongoing guidance.