Cottage Q&A: How the “bonus year” can reduce your capital gains tax

Cottage Q&A: How the “bonus year” can reduce your capital gains tax

Let’s say you own a home and a cottage at the same time for 20 years. They have both increased in value by a similar amount. You sell your home (principal residence) tax-free and move into an apartment. At that moment, you now claim your cottage as your principal residence. A year later, you sell the cottage. Is the cottage sold tax-free, or do you still have to claim capital gains tax for all those 20 years it was “not” your principal residence? If so, then your tax-free “saving” is only the last year in which you did not own two places. Is this correct?—Mark, via email

It’s almost correct. You’re forgetting about the “bonus year,” says Karen Slezak, a tax partner with Crowe Soberman in Toronto. The what now? “Well, we refer to it as a bonus year.”

You’re right that you can’t designate two principal residences at the same time. “For the cottage, you will not be able to claim any of the years that were designated for the home.”

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But you can claim a tax-free “bonus year” for the cottage—the year in which you actually sold your home, or, in the words of the CRA, “the year in which you replaced your principal residence.” So, says Slezak, “When you sell the home, you designate all the years except the year of sale, and you use the bonus year to cover the year of sale.”

But wait, there’s more! For the cottage, not only are you able to claim the year that was not designated on the home (e.g., the year you sold the home), you can also claim “the following year when you solely owned the cottage.” Then, says Slezak, there will be a bonus year “related to the second property sale—the cottage sale. So this means three capital-gains-tax-free years out of the 21 years.”

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The bonus year avoids the problem that arises when someone is selling a property in the middle of the year, says Slezak. “It’s just built into the formula.” An extra year or two isn’t going to amount to massive tax savings, she admits. “But every bit counts.”

Got a question for Cottage Q&A? Send it to [email protected].

This article was originally published in the March/April 2024 issue of Cottage Life.

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