If you spent time at a cottage or cabin in Canada, or ventured further abroad to vacation this summer, odds are you’ve thought about having your own getaway. Getting away from the hustle and bustle of daily life, enjoying nature, spending time with family and friends – from a lifestyle perspective, owning a recreational property is a great investment. But what about the financial aspect?
Here are a few things you should think about before you seriously consider purchasing a vacation property.
1. Potential for rental income
Renting out your vacation property when you’re not using it can help offset some expenses and potentially generate rental income. Wondering whether a property may have good income potential? Consider factors like location, accessibility, amenities and rental demand in the area.
Managing a rental property requires time, effort, and additional costs for marketing, maintenance and cleaning. Short-term rental services like Airbnb or VRBO can offset some of these costs, but in certain areas there are rules in place that restrict short-term cottage rentals through online sites like these. Not only that, but zoning restrictions and noise laws can also play a factor.
2. Potential property appreciation
Historically, real estate has shown potential for long-term appreciation but there are no guarantees. Be sure to research the local market trends and find out where the best areas to buy are. Ultimately, however, the best type of recreational property is the location, activities, and prices that suit you and your family.
3. Possible tax deductions
If you rent your property out, you can deduct relevant rental expenses from your earnings. Related costs like advertising, insurance and repairs all apply, but be sure to carefully track your expenses and save your receipts. Consider working with an accountant when it comes to tax time so you don’t miss any opportunities to save on tax.
1. Tax issues
In Canada, if you designate your recreational property as your principal residence, you may be eligible for the Principal Residence Exemption (PRE) for tax purposes. The PRE can help to reduce the amount of capital gains tax payable on the sale of the cottage, provided it meets the eligibility criteria. For example, if you rent your cottage out, it may not qualify as your principal residence – be sure to speak with an accountant about this. Moreover, your family can generally only designate one of your properties as your principal residence each year, so it’s important to consider the potential impact of designating your cottage as your principal residence over your main home.
Be sure to educate yourself on any federal, provincial and/or municipal “vacancy taxes” that may apply, depending on where your property is located. For example, there is a federal “Underused Housing Tax” that could apply to residential property in Canada that is not legally owned by individuals who are Canadian citizens or permanent residents.
Make sure you’re aware of the Harmonized Sales Tax (HST) or Goods and Services Tax (GST) implications when you purchase a recreational property. Generally, a resale property is exempt from HST/GST, while newly constructed properties are subject to these taxes. However, there may be certain rebate programs or exemptions available depending on the province or specific circumstances, so be sure to consult with a tax professional to learn what applies to you.
Finally, make sure you’re aware of potential land transfer tax that may apply, depending on the province.
2. Insurance challenges
It may be challenging to insure a recreational property, depending on where it’s located – remote areas that are far away from a fire hall, for example. Other barriers could include weather-related risks like floods or wildfires, the property’s seasonal use and the type of property – cottage, cabin or trailer, etc. Be sure to get an estimate on insurance premiums before you buy so you don’t wind up paying more than you budgeted for.
3. Unexpected financial costs
Be sure to assess your financial capability to purchase a recreational property. Consider factors like the down payment, mortgage rates and closing costs, and don’t forget ongoing expenses. New vacation property owners for example, are often surprised by the cost of property taxes, utilities, renovations and maintenance. Make sure you can comfortably afford these expected – and unexpected – costs without stretching your budget.
Also consider your long-term goals for the property. Do you ultimately plan to leave it to the next generation? If so, understand that income tax would be charged on any accrued capital gains on the property on your death.
Do you have sufficient other assets to fund this liability? In some cases, the use of life insurance can be a tax-effective and cost-efficient strategy to generate liquidity to fund tax at death and ensure the property is passed to the next generation. A life insurance policy can also provide a source of funding for your heirs to maintain the upkeep of the property in future. For families in which some children are interested in inheriting the property while others are not, life insurance can be an excellent way to equalize the estate by naming the children who are not receiving the property as beneficiaries.
The final analysis
Not every choice needs to be about money, and buying a recreational property can be a great lifestyle decision. However, from an investment standpoint, there are better options. If you add up your mortgage payment and the costs associated with owning a recreational property, you might find that your money could be better spent paying down debt or investing in a TFSA or RRSP. Not only that, but if you decide to sell, gift, or bequeath your property in the future, you’ll incur a capital gains tax – 50% of the value of any capital gains in Canada are currently taxable.
Learn whether purchasing a recreational property makes sense for your financial situation.