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The improvements you make over the years to a cottage or investment property can save you on taxes when you sell.
Coming changes to the capital-gains inclusion rate have jolted not just wealthy Canadians, but also people with long-held cottages or a second property owned as an investment. Starting June 25, they will have to pay tax on two-thirds of the capital gain above $250,000; half of gains up to that threshold will be taxable. Currently, the 50-per-cent inclusion rate applies to all capital gains.
A capital gain is the selling price minus the purchase cost, acquisition costs and the amount spent on improvements made while you owned the property. This combined amount is called the adjusted cost base.
Tax expert Armando Minicucci recalls an interaction with a client who sold a secondary property and was in a panic about what was seen as a big tax liability.
“I sat down with them and said, okay, you’ve owned this property for however many years – come up with a list of all the capital improvements,” said Mr. Minicucci, a partner in the tax practice at accounting and business advisory company Grant Thornton. “They came up with the list and it significantly reduced the resulting capital gain.”
Mr. Minicucci said the calculation of the adjusted cost base on a property starts with the price paid, including land-transfer tax and legal fees. “From that point on, it’s whatever would be considered a capital improvement to the property from the time that you acquired it to the time that it’s disposed of.”
Improvements are distinct from maintenance and upkeep, which are about keeping the property in its original condition. Mr. Minicucci said improvements upgrade the property, and cited examples such as having a garage or an addition built.
A new roof is an example of how the distinction between maintenance and improvements can be tricky. Mr. Minicucci said merely replacing a roof is just maintenance, but adding a superior-quality, longer-lasting roof could be considered an improvement.
You should have receipts or records of improvements you plan to include in your ACB. But Mr. Minicucci said evidence in a photo may help support the claim that you made capital improvements.
Now, for a quick example of an ACB calculation for someone who bought a cottage many years ago for $300,000 and paid $5,000 in closing costs. Over the years, they added improvements costing $100,000, bringing the adjusted cost base to $405,000. This amount would be subject to the Canada Revenue Agency asking for more details on the improvements made.
The cottage is sold for $800,000, which means the capital gain would be $395,000. Under the new inclusion rate, half the first $250,000 of that amount would be taxed at the owner’s marginal tax rate and two-thirds of the remaining $145,000 would be taxed.
Mr. Minicucci said it’s not uncommon for people to overlook the cost of improvements when calculating the capital gain on the sale, especially in cases where the sale takes place after the death of the owner. But the tax savings can be significant. In the above example, the amount of the capital gain is reduced by $105,000.
You’ll also want to use ACB when calculating the capital gain on the sale of securities such as stocks and funds. Monthly or quarterly statements from investment companies typically provide the book value or book cost for account holdings, which is the same as ACB.
However, Mr. Minicucci cautioned that book values in a investing account statement may not be 100 per cent accurate. “You’ll notice that there are caveats on all those brokerage statements that tell you that they’re not responsible for the calculation of your tax bases,” he said.
Book value on an investment statement represents the cost of your holdings plus transaction costs such as commissions, reinvested dividends and/or distributions such as a return of capital. Mr. Minicucci said financial institutions may in some cases miss the return of capital, and thus show an inaccurate book value.
One way to cross-check your book-value numbers is to use the AdjustedCostBase.ca website. Simple calculations can be done for free, and there’s an upgraded service at $49 a year.
How likely is it that your book value is questioned by CRA? Mr. Minicucci said he’s never seen an ACB on a stock questioned, but he has noticed an overall increase in the CRA scrutiny in recent years and reinforced that it’s the taxpayer’s responsibility to support their ACB calculations.
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