Navigating Your Prized Cottage Investment

July 2, 2024

Cottages were all the rage in recent years past—and that’s precisely why they’re still an investing hot topic in 2024.

The COVID-19 pandemic compelled the Bank of Canada to drop its overnight lending rate to a historic low of 25 basis points. The result was predictable: a frenetic rush for housing across the country. However, because employees had by then begun working remotely, they suddenly had the freedom to live anywhere and cottage country became a natural destination.

Recreational property prices in Quebec rose by 24.5% year-over-year in 2021, and in Ontario, they surged by 34.6%. Those located on waterfronts increased by 26.4% and 31.8%, respectively.

But that scorching, unanticipated explosion of buyer demand for cottage properties now poses a dilemma. Following years’ worth of demand frontloading into a span of roughly a year and a half, the cottage market experienced such a rapid pace of price increases that sales activity softened on account of there being too few buyers willing, or capable, of meeting those thresholds.

Signs of risk then appeared in the cottage market when the Bank of Canada implemented an aggressive quantitative tightening regime that left some of the more impetuous buyers unsure they would be able to renew their mortgages at higher rates in the immediate years ahead. And because cottage prices still hadn’t moderated enough to renew demand, some sellers, desperate to sell, were left regretting their purchases.

Cottages remain sound investments

However, in the years since, Canadian cottage markets have largely returned to normalcy. Unlike the residential housing market, which remains buoyed by imperatives like population growth and has therefore only experienced modest corrections, fewer complicating factors govern Canada’s cottage markets.

But while that once again makes cottages, as an asset class, a shrewd addition to one’s portfolio, these purchases aren’t for the uninitiated because cottages are infamous for their confusing tax structures.

Cottages are considered capital assets, so if they are not designated as your principal residence (principal residence are exempt from capital gains) and passed down to a family member, there will be tax implications. If left to an heir in a will, the cottage will be deemed to have been sold at fair market value and any increase in value, minus the cost of improvements, will be considered capital gains and taxed at the deceased’s marginal tax rate. This could trigger a $100,000 to $200,000 tax bill, which in the worst-case scenario could require the beneficiary to sell the property to pay the tax bill.

One way to prepare for such a capital gains bill is through a family-funded life insurance strategy. As mentioned, it is also important to track all expenses that go towards improving the cottage, as they could provide a little additional tax relief.

Rather than leaving it to your heirs in a will, there is also the option of creating a trust that owns the cottage. This is deemed a disposition by the Canada Revenue Agency but it’s a strategy that could help avoid legal issues in the future. Moreover, the parents can still control the cottage and name their children as beneficiaries. It would also avoid probate issues later on.

Trusts require separate tax returns, which can be somewhat confusing, but by having a deed of gift, because cottages are often the subject of intense litigation between family members, courts put them through estates. Moreover, trusts are also needed to satisfy questions pertaining to who has rights to the cottage, as well as when, and who is responsible for maintenance or further development. Trusts can also dictate whether a sale to a third party is permitted. In short, trusts ultimately preclude internal family squabbles over the cottage.

Another option is to sell and give the proceeds to the kids, letting them decide what to do with the money. This is the unsentimental option, but it may be the best way forward for your family, removing future complications or potential conflicts.

A shadow looming over the capital gains issue is the upcoming changes, which are set to take effect on June 25, 2024. For those whose cottage has skyrocketed in value, it pays to be aware that the inclusion rate will increase to 66.7% for those realizing more than $250,000 in capital gains in a given year. Gains below this threshold remain at 50%.

Before the pandemic, it was uncommon for people to rent out their cottages, but with all flights grounded, cottages became popular short-term rentals. And the trend is as strong as ever today. But potential cottage purchasers should consider it important to buy a cottage in the right place. Although cottages are most popular in the summer, certain places that offer year-round activities will yield cottage owners even better returns on their investment.

Canadians are already jumping headlong back into the recreational housing market. Royal LePage anticipates 8% growth in the single-family recreational housing market in 2024 in Ontario alone, and 5% nationally, which would bring average prices to $662,148 and $678,930, respectively.

However, there are also a lot of deals to be had out in the cottage country, following the massive rush north when COVID-19 hit. Moreover, with the last federal budget increasing the capital gains tax rate, many cottage owners are contemplating whether or not they should list their properties by the June 25 deadline. In that respect, there are indeed opportunities to be found on the market.

And for those contemplating a cottage purchase solely for leisurely enjoyment, it is imperative to sit down with your children when planning the estate and determine everything from who wants to use it and who doesn’t, how that affects a non-resident child, and who will be responsible for its upkeep.

All of these questions and more require the guidance of a trusted advisor.

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