Important tax considerations for Canadian cottagers

Tax season is officially open. As of Monday, Canadians can now file their 2023 tax returns. With a deadline of April 30, you may be turning to a good CPA to help navigate this year’s tax rules. For those tackling their taxes themselves—especially anyone who owns a cottage—there may be a few tax considerations you want to keep in mind.

New trust reporting rules

On October 27, 2023, the federal government announced new reporting requirements for trusts. Previously, anyone who held a beneficiary interest in a trust wasn’t necessarily required to report it. But now anyone who was part of a trust during the 2023 financial year must file a T3 return by April 2, even if no income was earned by the trust. Failure to file can result in a financial penalty that reflects the value of the assets held in the trust.

This means more paperwork for cottagers who own their property through a trust. One of the most common types of trusts used with cottages is a family discretionary trust. Parents often use this type of trust to pass the cottage down to their children. “The structure is popular among some taxpayers because it provides some creditor protection. The cottage is not directly exposed to creditors of individual beneficiaries,” says Anna Malazhavaya, a tax lawyer with Advotax Law. This means if one of the children goes bankrupt, the other siblings won’t lose the cottage as a result. A family trust also defers capital gains tax until the property is sold or until the trust has been in place for 21 years.

Another popular cottage trust is a bare trust. In this type of trust, one person holds the legal title of the cottage, but a second beneficiary has rights and responsibilities over the property. The most common example is a family member, such as a parent, registering the cottage’s title and mortgage in their name to help their child purchase the property. The child, however, has full financial responsibility over the cottage. Previously, bare trusts didn’t have to be reported to the Canada Revenue Agency (CRA), but under the new rules, both the trustee and the beneficiary must file returns.

“The obligation is on the parent (or trustee) to file the annual T3 returns. If the parent fails to file the returns, the CRA may go after them (and not the child) for any tax resulting from renting or selling the cottage,” Malazhavaya says.

Underused Housing Tax

On January 1, 2022, the federal government introduced the Underused Housing Tax (UHT). It’s a federal one per cent tax levied annually on the ownership of residential properties occupied for less than 180 days per year. The tax targets foreign buyers who are snapping up Canadian properties and turning them into short-term rentals or leaving them vacant.

Canadian citizens are technically exempt from the tax, but some unfortunate wording in the legislation has inadvertently targeted a select group of Canadian property owners. While Canadian citizens who directly own a property don’t need to file a return, any Canadian who owned a residential property through a trust in 2022, including a cottage, must file a UHT return by April 30.

The federal government has changed the wording of the UHT so that moving forward people who own residential properties in a trust won’t have to file a return, but this doesn’t apply for the 2022 financial year. Due to the confusing nature of the issue, the government has pushed the filing deadline to April 30 of this year. Canadians affected won’t have to pay the tax, but they will have to file the return.

Cottage rental tax

As many cottage owners will point out, the number of cottage rentals in Canada has exploded since the start of the Covid-19 pandemic. Renting out their cottage has become a way for many owners to afford their mortgage. But renting out your cottage makes you subject to taxes.

“If you rent out your cottage, that’s technically income. So, you have to pay income tax on those revenues,” says Phil Aldrich, a lawyer with LLF Lawyers.

It isn’t all bad news, though. Since operating a rental is a business, cottage owners can claim expenses, such as insurance, repairs, and internet. It may even be possible to claim a portion of the mortgage. But to claim these expenses, cottage owners must calculate the percentage of the year they rented out their property. For example, if someone rented out their cottage for three months of the year, they could claim 25 per cent of their annual insurance, internet costs, etc.

To avoid any costly financial penalties, cottagers should always double-check the calculations on their rental expenses. “The CRA has really clamped down on what you can write off, but if you keep accurate records when you’re going through the rental process then they are legitimate expenses,” Aldrich says.

Enforcement of federal government’s tax laws on short-term rentals could be difficult