A friend recently asked me about the best way to deal with the income tax that will need to be paid when his parents eventually pass away.
The most common way to offset this future tax liability is through the use of insurance and have I written about this strategy in Planning For The Family Cottage. However, there is another strategy that can be effectively used, provided you have all the receipts!
Keep Your Renovation Receipts
When you pass away or sell your cottage or vacation property, you generally cannot claim the principal residence exclusion and the sale attracts the tax on capital gains. If you have done renovations to your vacation property, you have increased the “adjusted cost base” of the property and this can lower the future capital gain.
If the cottage you originally paid $20,000 for is currently worth $250,000 you will have to pay tax on 1/2 of the gain (or $115,000 will be added to your income tax return). If you live in Ontario and are in the top tax bracket, the tax bill could be over $53,000.
However, if you made improvements to the property over the years, the cost of these improvements can be added to the original $20,000 cost to offset the gain.
Assume that over the years you replaced the roof a, added an addition and build a new boat house. If the total cost of these improvements over the years amounted to $35,000, you will have reduced that future tax bill by more than $8,000.
Clearly keeping the receipts is essential when making improvements to your vacation property.