Deemed disposition of a cottage

[PDB]

If my wife and I sell our home which is our principal residence and move into our cottage that we have owned and used for personal use only for 5 years, do we have a deemed disposition on the cottage the day we move it and have to pay capital gains tax on any increase since we've owned it?

[clw]

No. When you own multiple personal use properties over the same time period, you are free to designate one of them per year as a principle residence, even if you just occasionally stayed there. So the idea is to determine which property will accrue the most in value over time and designate a maximum number of years to that  property to shield its future capital gains. In your case, you could reserve some years on your main residence (and pay some capital gains) and designate them to your cottage.  The fiscal formula used in the T2091 form is: (number of years designated +1)/(number of years owned) x price sold = capital gains exempt from taxation.  So if you designate all years owned to your main residence, the year you move to your cottage will result in 1 year of cottage designation. If there was a change of use of your cottage 5 years ago, then a deemed disposition should have been filed at that time. If you owned the cottage for 5 years and you were to sell and move away the year following your initial move then (2+1)/5 would be the capital exempt from tax.

[Geo123]

Hello PDB,,

 

Deemed Disposition
When there is a change in use of real estate, either from income-producing to personal-use (e.g., principal residence or cottage/second home), or from personal-use to income-producing, there is a deemed disposition.  The owner is deemed to have disposed of the property (land and building), and to have immediately reacquired it, with both transactions done at fair market value.

 

FYI : S. 45(3) Election - Defer Capital Gain Until Property Sold
When there is a capital gain, under certain circumstances the gain can be deferred by making an election under subsection 45(3) of the Income Tax Act.  S. 45(4) of the Income Tax Act does not allow the election to be made if capital cost allowance (CCA) has been claimed "in respect of the property" for any taxation year ending after 1984.  If any CCA was claimed prior to 1985, this may result in a recapture of that  CCA.
To make the election, a letter should be filed with the income tax return for the year in which the property is eventually sold, or within 90 days of a formal demand for the election from CRA.
If a Quebec tax return is also being filed, a copy of the election should be sent to Revenu Quebec.
Further information on this election can be found in CRA Guide T4037 Capital Gains.
Change in Use From Personal-Use (Principal Residence or Cottage) to Income-Producing Rental Property
When the property use changes from personal-use to income-producing , the deemed disposition can result in a capital gain.  This is calculated by deducting the adjusted cost base of the property from the fair market value at the time of change in use.  The fair market value at the time of change in use is the new adjusted cost base of the income-producing property.  However, there are special rules to determine deemed capital cost of the depreciable portion of the property, if the fair market value of the depreciable property (building, for example) is greater than its cost to the taxpayer.  See CRA's Change in use rules regarding CCA, deemed capital cost, and recapture.  See also the Tax Court Case Donaldson v. The Queen, 2016 TCC 5.
Note that if the property is not located in Canada, and the new adjusted cost base is over $100,000 in Canadian dollars, there will be a requirement to complete form T1135 foreign income verification statement each year in the future while the property is owned.
https://www.taxtips.ca/personaltax/propertyrental/real-estate-change-in-use.htm