Did the new capital gains rule trigger a cottage sale frenzy?

What is changing?

The federal government's proposed change to capital gains taxation is expected to increase taxes on certain investments, including selling a cottage or a secondary residence. Here's what you need to know about the change to capital gains taxation.

In a bid to make rich individuals and corporations pay more taxes, the federal Liberals said they will increase the capital gains inclusion, the share of capital gains that is taxed, from 50% to 67%. The change will apply to those with more than $250,000 in capital gains in a year, starting June 25. All corporations and trusts will also have to pay taxes on a bigger portion of their gains. At the same time, the lifetime exemption limit for farming and fishing properties and small business shares is increasing to $1.25mill.

The government said the change will affect the wealthiest 0.13%, about 12% of Canada's corporations, as well as Canadians with an average income of $1.42 million. It is expected to rake in $19.3 billion over the next five years.

What is Capital Gains Tax?

The capital gains tax is the tax individuals pay when selling an asset or capital property. Capital gains are the profits from that sale. Common types of capital properties include cottages, securities (such as stocks, bonds and units of a mutual fund trust), land, buildings and equipment you use in a business or a rental operation.

Canadians must report taxable capital gains as income on their tax return. Under the Liberals' new plan, the capital gains inclusion rate would rise from 50% to 67% for those with more than $250,000 in capital gains in a year. A capital gain is the difference between the sale price and the total of a property's purchase price, including acquisition costs, and any expenses incurred from the sale. Once the new rate of 67% takes effect on June 25, the capital gains tax will be higher for amounts over $250,000, but amounts $250,000 and below will be taxed at the old 50% inclusion rate.

What is an inclusion rate?

It’s the amount from your capital gains that is actually taxable. So, as of now, 50% of your gains are tax free, and after June 25, 33% of your capital gains are tax free. As long as your total capital gains are below $250,000, the old rule will apply.

How does capital gains tax affect homeowners?

Canadians will feel the impact of this tax change, such as through the sale of their cottages and other secondary residences, or rental properties. If you look at the appreciation and property values in the last three or four years, there are several people who bought cottages before COVID when they were still relatively cheap. Now, if they were to sell that same cottage, some of these values have, at least temporary, doubled or tripled. A capital gain is realized when you sell your home, but you don't have to pay tax on the gain if the property was solely your principal residence for every year you owned it. A principal residence can apply to a house, cottage, condominium, apartment in an apartment building or duplex, trailer, mobile home or houseboat.

Frenzy?

John Fincham, a broker with Re/Max Parry Sound Muskoka Realty in Muskoka, Ont., recently told BNN Bloomberg the change could cause a correction in the cottages and recreational property market and that some owners may rush to sell before the higher tax rules kick in. Now there are ‘media reports’ circling about a cottage selling frenzy. While listings are up, there is no selling frenzy because of the changed capital gains rule.

Cottage sales went crazy during covid. Summer and fall of 2020 saw bidding wars with 50%-70% over asking price. People who bought these places for a quick gain, have now trouble unloading them. That explains the increased listings and retrieval of prices of these (still overpriced) cottages. People who are planning to keep their cottage in their family for generations to come, are not selling now because the capital gains inclusion rate went from 50%-67%, unless they changed their mind for other reasons, or received bad financial advice.

Early planning is key

While properties have experienced tremendous increase in value and therefore a larger capital gains liability, proper planning can cushion the effect of taxes on the next generation. If you are unsure of being affected or not by this new rule and we haven’t talked about it yet, contact me.