Many cottage owners are feeling the pressure from the proposed change to the capital gains inclusion rate. Under the old rules, 50 percent of the capital gain would be added to your income. Under the new rules, you will have to include 66 percent of the gain on any growth above $250,000. So, how do you get around this? Let’s discuss the capital gains reserve.
Prefer to watch the video?
What Is the Capital Gains Inclusion Rate
When you sell an asset like a cottage, only a portion of the capital gain is included in your taxable income. Currently, that inclusion rate is 50 percent. The proposed change would keep the first $250,000 of gains at 50 percent but increase the rate to 66 percent on any amount above that.
This means more of your gain will be taxed and at a higher effective rate.
A Real-World Example
Let’s say you purchased a cottage 30 years ago for $200,000. Today, it is worth $1.2 million. That is a $1 million capital gain.
Under current rules, 50 percent of that gain, or $500,000, would be added to your income. If you are in Ontario’s top tax bracket, that results in a tax bill of about $267,000.
Under the proposed rules, the first $250,000 of the gain would still be taxed at 50 percent, but the remaining $750,000 would be taxed at 66 percent. This increases your taxable income to $620,000 and your estimated tax bill to just over $331,000.
That is a difference of more than $64,000 in additional tax.
Can You Avoid Tax by Gifting the Cottage
Not exactly. If you gift your cottage to your children, the CRA still considers it a sale at fair market value. That means the full capital gain is triggered, even if you do not receive any payment. You still owe the tax, but now you do not have the sale proceeds to cover it.
How the Capital Gains Reserve Could Help
One strategy that may reduce the impact of the higher capital gains inclusion rate is to use the capital gains reserve.
Instead of selling the cottage all at once, you can structure the sale to be paid over five years. For example, your children could pay you $240,000 per year rather than $1.2 million up front.
This lets you spread the capital gain across multiple tax years. Because your original cost was $200,000, you can also allocate that cost evenly over the five years. Each year, you report $200,000 in capital gains, staying under the $250,000 threshold. That keeps you within the 50 percent inclusion rate, not 66 percent.
To do this properly, you would need a formal agreement, such as a promissory note or structured payment schedule. Your accountant and lawyer should be involved to ensure it is set up correctly.
Final Thoughts
The proposed increase to the capital gains inclusion rate may affect more Canadians than expected, especially those who own cottages or other valuable secondary properties.
If you are considering selling or passing down a property with significant gains, planning ahead could save you and your family thousands in taxes.
