How Vacation Homes Are Taxed at the Time of Sale

Selling a vacation home is going to take a little more energy than selling a primary residence because the two are taxed so differently. The process becomes even more complicated if sellers generated rental income during their time of ownership. What are the tax implications of selling a second home? To understand the full implications of a sale, sellers should know the basics of capital gains, capital losses, and depreciation before putting the home up on the market.

For informational purposes only. Always consult with a certified tax expert before proceeding with any real estate transaction.

Capital Gains Tax: How It Works

How does capital gains tax work? A capital gain refers to the total cost of appreciation from the time the asset was purchased to the time it was sold, with the end result taxed based on the owner's income. So, if the home was purchased at $300,000 and sold for $500,000 (after deductions), the owner would have a capital gain of $200,000. In Canada, people selling their primary homes have generous leeway when it comes to deducting most (if not all) of their capital gains. However, a person selling a vacation home will not be given the same considerations. Selling your second home without capital gains taxes is next to impossible.

Capital Gains Tax: How It's Calculated

How are capital gains taxed? Capital gains are taxed at half the total value on a progressive income scale. In the case of the above example, it would be $100,000. Those in the top income brackets would end up paying a full 43% of the assessed capital gains, or $43,000 in capital gains tax. The most common way to reduce capital gains tax is to keep track of the seller's improvements to the home. So if a seller completed a $15,000 kitchen remodel, they can add that cost to the original sale price of the home, thereby lowering the total capital gains. (The taxation of capital gains began in 1972, so only gains accrued after that year will count.)

Primary Residences

Because primary residences aren't subjected to capital gains, sellers can potentially use this rule to their advantage during the year they sell their home. If the vacation home has accrued more in capital gains than their primary residence, then they can move into their vacation home during the year of sale as a loophole to paying the full cost of capital gains. They do not necessarily need to stay in their residence for the full time, but they will need to prove they lived there at some point. Coopers Crossing homes that are being rented out during the year will have separate rules. This particular option can be complicated in terms of paperwork and requirements, but it could be a good way to legally avoid a major financial hit.

Additional Options

Canadians can deduct capital losses from their capital gains, meaning it may make more sense to sell off the primary residence along with the vacation home if the primary residence has plummeted in value. Owners can also donate their gains to a registered charity during the sale calendar year so they can receive a tax credit. This credit can potentially reduce the amount of total taxes owed for capital gains on the sale of second homes. The Canadian Revenue Agency will also sometimes grant extensions to the taxation if sellers expect a long escrow period after selling off their second home.

Selling a vacation home can still be a profitable decision if sellers understand how to calculate capital gains tax. Because the rental and primary residence rules can be tricky though, it helps to consult with a real estate agent or financial planner to make the process go run more smoothly.

For informational purposes only. Always consult with a certified tax expert before proceeding with any real estate transaction.