Investment properties and tax considerations

Frequently asked questions

If you own an investment property, it’s important to consider the potential tax liabilities you may incur when you sell it or bequeath it to your heirs. A qualified tax advisor can help you develop an optimized strategy based on your specific circumstances. Below we address some of the most commonly asked questions.

1. What are some strategies to consider when discussing the tax liability on a cottage property?

• Using the principal residence exemption on the cottage property instead of the family residence.
  It would be important to determine which of the two properties has a larger average capital gain per year and to designate that property as the principal residence.
• Addressing the capital gains from now so that it is immediately payable.
  This may be a good option if an individual wants to gift or sell the cottage to their children. They may consider using a “capital gains reserve” to arrange the sale in a way that allows them to spread the gain over five years. They can have the children pay with a promissory note. They are then able to forgive the promissory note in their will, making the cottage property a gift.   
• Life insurance.
  This can provide liquidity to the estate so that there are enough funds to cover the capital gains tax and other tax liabilities arising out of the deemed disposition. 

2. Can a tax-deferred rollover of the cottage take place with an adult child(ren)?

No. A tax-deferred rollover is only available to a surviving spouse, and it is not available to the children. To transfer the property to a child, an individual would either need to gift the property while alive or on death; sell the property; or move the property into a trust.  

3. Is it better to gift the cottage or sell the cottage?

• Gift:
  Gifting the property to children would create a deemed disposition at fair market value (FMV). This would result in a tax implication for any appreciation in the value of the property. Additionally, with this transaction, the FMV of the property at the time of gift would become the new adjusted cost base (ACB) for the children.  
  
  
• Sell:
  Selling the property would also trigger capital gains. However, as discussed earlier, an option that could be available with this strategy is claiming a capital gains reserve and this would allow an individual to spread the tax liability over a span of up to five years using the reserve formula. 

4. What happens when you sell the cottage property to your child(ren) below FMV? 

Selling the property at a discount could result in double taxation. An individual would pay the tax as if they had received FMV for the property, but the children will have an ACB equal to the amount they paid.

5. Should I consider a cottage co-ownership agreement?

If the cottage will be shared with multiple owners, a co-ownership agreement could be a good choice. It acts as a roadmap dealing with decision-making and dispute resolution in advance. This agreement should discuss all relevant items, including what should happen if one party would like to sell their interest, how time at the cottage will be divided and other routine items such as how maintenance will be handled. Each party should receive independent legal advice before signing an agreement. 

6. How will an individual be affected by the capital gains inclusion rate announced in the 2024 federal budget?

The capital gains inclusion rate increased from one-half (50%) to two-thirds (66.67%) for capital gains realized on or after June 25, 2024.

The capital gain from the sale of a principal residence remains exempt from tax. However, the new inclusion rate will affect capital gains from other types of investment properties including cottage and vacation properties, rental properties, condominiums, etc.

When deciding whether to sell a property, it is important to consider all factors, including the tax implication, what the short-term and long-term goals are for the property, the rate of return, etc. If the original intention was not to sell or transfer the asset, it will likely make sense to hold onto the asset. It is important to receive advice from an accountant and lawyer before making any decisions regarding the sale of an asset based on the proposed changes coming out of the budget. 

7. What is a bare trust and what are the reporting requirements?

A bare trust is not defined in the Income Tax Act, but it is defined by CRA as an "arrangement under which the trustee can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust's property."

This differs from an express trust, where a trust deed is usually prepared by a lawyer to create a trust. Bare trusts could come from adding an adult child onto a bank account or a parent co-signing a child’s mortgage and becoming an owner. The trustee has no beneficial interest in the property but is a legal owner. They are essentially acting as an agent on the true owner’s behalf. A bare trust generally doesn’t create a taxable event but as of 2023, there is now a reporting requirement changing the reporting obligation but not the tax treatment.

Under the new reporting rules, the trustee of a bare trust must file an annual T3 trust return for years ending after December 30, 2023. The deadline to file is 90 days after the tax year-end. There are several exceptions that create an exemption from the new reporting requirement, including bare trusts that have existed for less than 90 days, those holding less than $50,000 in assets, etc. There are penalties for non-compliance including a late-filing penalty. 

8. What is the Underused Housing Tax (UHT) and who is affected?

The UHT became effective on January 1, 2022, and is essentially a 1% tax on the value of non-resident, non-Canadian-owned residential real estate that is considered to be vacant or underused. There is also a reporting requirement, and the due date is April 30 of each year. All owners of a residential property, except those who can be identified as an excluded owner are required to file a UHT return. There are several criteria and exemptions so it will be important to determine if you are considered an affected owner. 

9. What is tenancy in common vs. joint tenancy?

Tenancy in common is a form of joint ownership allowing for unidentical interest in the ownership of the property. There is no right of survivorship meaning that when an owner dies, that person’s last will (or the rules of intestacy) deals with their interest in the property. In addition, there is a deemed disposition of the deceased owner’s interest, which could trigger a tax implication.

Joint tenancy is a form of joint ownership where the interest each owner has in the property is identical in that each owner essentially owns 100% of the jointly held property. On the death of a deceased joint tenant, the property passes to the surviving joint tenant by way of the right of survivorship. 

This should not be construed as legal, tax or accounting advice. This material has been prepared for information purposes only. The tax information provided in this document is general in nature and each client should consult with their own tax advisor or accountant. We have endeavoured to ensure the accuracy of the information provided at the time that it was written, however, should the information in this document be incorrect or incomplete or should the law or its interpretation change after the date of this document, the advice provided may be incorrect or inappropriate. There should be no expectation that the information will be updated, supplemented, or revised whether as a result of new information, changing circumstances, future events or otherwise. We are not responsible for errors contained in this document or to anyone who relies on the information contained in this document. Please consult your own legal and tax advisor.