Everyone needs a vacation, especially in this winter climate. Whether it’s a cabin, a condo or an additional house, vacation properties are a great way to spend time away from the farm for much deserved relaxation. Unfortunately, there are tax considerations to keep in mind with your home-away-from-home.
Specifically, tax consequences may arise if you are planning to rent out the property when you are not using it, if your property is in the United States, when it comes time to sell, or at the time of your death.
Renting out your vacation home
As weekend rentals become more popular, you might want a return on your investment by renting out your property. In this case, you will have to claim rental income on your personal taxes. Here are things to keep in mind:
If your vacation home is in Canada
Rental income is considered investment income for tax purposes and you will be required to claim it on your tax return by filing an extra schedule. This will likely increase your tax bill in April. The good news is you can deduct expenses against the income for the portion of the year that the property is being rented.
Ensure you keep all of the receipts and reach out to your trusted advisor ahead of time if you are unsure what else may be required. You will also want to discuss whether the change in use rules apply (property classified as business versus personal) and the tax implications with your advisor.
If your vacation home is in the U.S.
Rental income from a property in the U.S. requires further considerations. A withholding tax of 30 percent applies to rental income earned by a Canadian on U.S. property. However, there is an election to use the “net rental income” method, which would account for your expenses. This could mean a lower tax bill.
In the U.S., deprecation is an expense that you are required to claim if you have rental income. The good news is this will lower your taxable income and therefore your taxes. The bad news is, this can reduce the cost base of the property leaving you subject to a larger tax bill when you eventually sell.
People who spend the winter south of the border must be careful how long they plan to extend their stay. Spending too many days in the U.S. could put you in a situation where you are deemed a U.S. resident for tax purposes (often, people confuse immigration and tax rules in this area). If you stay in the U.S. for more than 120 days each year, you could be deemed a U.S. resident (the actual test is a three-year calculation).
To avoid being deemed a U.S. resident, you may need to file a “closer connection” form if your days in the U.S. in the current year are less than 183 but you are over on the three-year calculation.
Selling vacation homes
There may come a time when you decide to sell your cottage and begin a new adventure. Tax planning in advance can ensure that you are attacking the potential tax bill early.
Consider applying the principal residence exemption of the sale of your property. This will result in reduced or possibly nil taxes on the sale.
If your property is out of the country, there are going to be extra filing requirements for the respective country.
No one wants to be worried about taxes on vacation, not even accountants. Make sure that your tax specialist is helping you to plan ahead so you do not come home to an unexpected tax bill.
Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: firstname.lastname@example.org.