Paying capital gains when selling a cottage to a family member

In your case, Terry, it sounds like the sale of your half of the family cottage to your niece has already occurred. So, the key is figuring out what tax implications will result.

Can a family cottage be exempt from capital gains?

It depends. A capital gain occurs when you sell certain assets for a higher price than what you paid for them. Capital gains tax became payable in Canada in 1972. Prior to that, capital gains in this country were not subject to tax. (More on that later.) However, some assets are specifically exempt from capital gains tax. These include:

• Capital gains on an eligible principal residence
• Capital gains on qualified farm or fishing properties up to $1.25 million
• Capital gains on qualified small business corporation shares up to $1.25 million
• A Canadian entrepreneurs’ incentive of up to $2 million to be phased in between 2025 and 2034 for $200,000 each year
• Capital gains on investments held in tax-sheltered or tax-free accounts, like registered retirement savings plans (RRSPs), tax-free savings accounts (TFSAs), registered education savings plans (RESPs), first home savings accounts (FHSA) and so on.

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Can you claim principal residence for a cottage?

You may be eligible to claim a principal residence exemption on the cottage proceeds, Terry. A taxpayer and their spouse are entitled to designate a property as their principal residence and claim a capital gains exemption for some or all of the years that it was owned by them. Prior to 1982, each spouse could designate one property as their principal residence for any given year, but after 1981, spouses could only designate a single property as their principal residence as a family unit for each year of ownership. A principal residence can include a cottage.

When not to claim a cottage as a principal residence

If you also own a home, Terry, it may not be advantageous to claim a principal residence exemption on the cottage sale. This is because you only own half the cottage and, unless the capital gain is a large one, claiming it as your principal residence may open you up to a much larger tax bill in the future upon the sale of your home.

Let’s assume that you owned the cottage for 20 years and you claim a principal residence exemption on it, Terry. If you owned your home for all 20 of those years and you sell your home in the future after owning it for 40 years, 20 out of those 40 years you will have designated another property as your principal residence. This will make half of the capital gain—20 out of 40 years—taxable on the sale of your home.

Do capital gains tax apply to a property sale between family members?

A sale or even a gift of an appreciated asset to a family member—including a cottage—may result in a capital gain. Sales or gifts of assets to family members generally take place at fair market value, so using an artificially low value is not a viable way to reduce or eliminate a capital gain.

One exception to the “fair market value” rule is when a transfer is made of an asset from one spouse to another. This will generally take place at its original cost unless you make a special election to transfer it at a value between the cost and the fair market value. The income or capital gain that results thereafter may, however, be attributed back to the gifting spouse—unless the transfer occurs on death.