Tally your receipts and grab a paintbrush -- it's time to sell the cottage
By Michelle Warren • Bankrate.com

One would think that finding out your property has appreciated by hundreds of thousands of dollars would be a good thing; but when the property in question is a vacation home and it's time to sell, a dramatic spike in fair market value can be a burden.

It's a lesson one unnamed professional hockey player learned the hard way after being traded to the US and opting to sell his Gravenhurst-area cottage. Seven years ago, the cottage cost about $150,000, but with close to $300,000 in renovations and demand driving prices skyward, the property sold in the $600,000-plus range, leaving the owner with a capital gain of $450,000. The surprise came in the form of a hefty tax bill.

"I just assumed he had an accountant who knew what he was doing," says the real estate agent who handled the sale.

Capital gains tax
While a family unit or primary residence is sheltered from capital gains tax, vacation properties, such as cottages, are not.

"As taxpayers, we pay capital gains tax on the gains we realize on the disposition of capital property, including real property," explains Nicole Ewing of BrazeauSeller.LLP in Ottawa. "Capital gains are calculated as the difference between the Adjusted Cost Base (ACB) of the property -- generally, the purchase price plus the value of any additions or improvements -- and the sale price. Fifty percent of the capital gain realized by the disposition of the property is added to the taxpayer's income and taxed accordingly."

Essentially, if you buy a cottage for $200,000 and sell it for $400,000, the gain is $200,000, which represents an increase in taxable income of $100,000 that will have to be reported on your next tax return. In most cases, you're looking at a tax bill of at least $25,000 (or more if you're a non-resident of Canada).

Reducing taxable income
Of course, there are ways to reduce the tax hit, and here's where it pays to be meticulous and keep receipts.

"As the capital gain is determined by subtracting the ACB from the sale price, increasing the ACB will reduce the gain," says Ewing. "The cost of additions and improvements to the property may be added to the original purchase price when determining the ACB."

In other words, expenditures on the cottage, be it a new dock, septic system, roof or kitchen renovation, can be used to legitimately offset the property's appreciation. In essence, these investments are deducted from the gain, thereby reducing the overall tax bill (in addition to major improvements, you can also deduct legal fees and survey costs).