How to Minimize Capital Gains Tax on Your Cottage: Smart Strategies for Retirees

Keep more of your cottage sale proceeds with these tax reduction strategies . . .

Owning a cottage is a dream for many retirees. It’s a place to relax, enjoy family time, and create memories in a peaceful setting. However, for those who may need to sell it in the future—whether for financial reasons or other circumstances—there’s the concern of capital gains tax. The good news is that there are strategies you can employ to reduce or defer the taxes you may owe when selling your cottage. Below, we explore some options to help you minimize your capital gains obligations.

How Much Capital Gains Tax Will You Pay?

A capital gain is the profit realized from the sale of an asset. It is the difference between the selling price and the asset's adjusted cost base (ACB), which includes the original purchase price plus any associated costs (like improvements or expenses incurred to sell the property).

Capital gains tax is generally calculated by including 50% of the capital gain in your income and taxing it at your marginal tax rate. Therefore, if your cottage was never considered your principal residence, half of the capital gain from its sale will be taxable at your marginal tax rate. 

However, the government has announced a significant change: Starting January 1, 2026, the capital gains inclusion rate will increase from 50% to 66.67% for individuals with capital gains over $250,000 annually, and for all capital gains realized by corporations and most trusts. This means you’ll pay more tax on your capital gains in the future, so it’s a good idea to consider these strategies sooner rather than later.

1. Designate Your Cottage as a Principal Residence

One of the most effective ways to reduce capital gains tax on the sale of your cottage is by designating it as your principal residence. This strategy allows you to shelter some or most of the capital gains from tax, depending on how long you’ve lived there and how long it has been designated as your principal residence.

However, there are a couple of key points to keep in mind:

• The cottage must meet the criteria to be considered a principal residence (you need to have lived there for a significant portion of the year).

• You can only designate one property as your principal residence per year, so you cannot have another property designated as your principal residence during the same tax year.

If you’ve used the cottage seasonally and lived there at least part of the year, or plan to spend a significant amount of time at the cottage during retirement, this could be a powerful way to reduce or eliminate your capital gains tax.

If you own both a home and a cottage, it's generally a good idea to designate the property with the highest potential capital gains as your principal residence, as this can maximize your tax savings by sheltering the larger capital gain from taxation. Of course, this is not an absolute rule, as there are many timing considerations involved. 

2. Keep Detailed Records of Capital Improvements

Have you made any major renovations or improvements to your cottage over the years? These capital improvements can be a game-changer when it comes to reducing your capital gains tax.

The concept here is simple: the Adjusted Cost Base (ACB) of your property includes the cost of improvements. If you’ve spent money on renovations such as a new roof, deck, or expanded living space, those costs can be added to the original purchase price of the cottage. When you sell the property, the ACB will be higher, which will reduce the capital gain—and consequently, the tax you owe.

3. Consider the Timing of the Sale

If you are able to plan when to sell your cottage, consider doing so in a year when your income is lower than usual. Capital gains are taxed at your marginal tax rate, which is determined by your total income. By selling in a year in which your overall income is lower, you will likely pay a lower rate on your capital gains.

For example, if you have a year in which you receive less income, it could be a good time to sell your cottage and take advantage of a lower tax bracket. This often happens when individuals retire and transition from full-time employment to receiving a pension. Similarly, this may be the case if other investments underperform in a given year, such as mutual funds, or vacant rental properties.

Final Thoughts

By planning ahead and using some of these strategies, you can likely minimize your capital gains tax and retain more of the proceeds from the sale of your cottage. If you have questions about your specific situation, it’s always a good idea to consult with a professional who can guide you through the process and help you make the most of your cottage in retirement.