The COVID-19 pandemic compelled the Bank of Canada to drop its overnight lending rate to an historic low of 25 basis points. The result was predictable: a frenetic rush for housing across the country. However, because employees had by then begun working remotely, they suddenly had the freedom to live anywhere and cottage country became a natural destination.
Recreational property prices in Quebec rose by 24.5% year-over-year in 2021, and in Ontario they surged by 34.6%. Those located on waterfronts increased by 26.4% and 31.8%, respectively.
But that scorching, unanticipated explosion of buyer demand for cottage properties now poses a dilemma. Following years’ worth of demand frontloading into a span of roughly a year and a half, the cottage market experienced such a rapid pace of price increases that sales activity softened on account of there being too few buyers willing, or capable, of meeting those thresholds.
Signs of risk then appeared in the cottage market when the Bank of Canada implemented an aggressive quantitative tightening regime that left some of the more impetuous among those buyers unsure they would be able to renew their mortgages at higher rates in the immediate years ahead. And because cottage prices still hadn’t moderated enough to renew demand, some sellers, desperate to sell, were left regretting their purchases.
Cottages remain sound investments
However, in the years since, Canadian cottage markets have largely returned to normalcy. Unlike the residential housing market, which remains buoyed by imperatives like population growth and has therefore only experienced modest corrections, fewer complicating factors govern Canada’s cottage markets.
But while that once again makes cottages, as an asset class, a shrewd addition to one’s portfolio, these purchases aren’t for the uninitiated because cottages are infamous for their confusing tax structures.
Cottages are considered capital assets, so if they are not designated as your principal residence (principal residence are exempt from capital gains) and passed down to a family member, there will be tax implications. If left to an heir in a will, the cottage will be deemed to have been sold at fair market value and any increase in value, minus the cost of improvements, will be considered capital gains and taxed at the deceased’s marginal tax rate. This could trigger a large tax bill, which in the worst-case scenario could require the beneficiary to sell the property in order to pay it off.
One way to prepare for such a capital gains bill is through a family-funded life insurance strategy, which creates a future pot of money to use for estate taxes.
A shadow looming over the capital gains issue is the upcoming changes, which are set to take effect on June 25, 2024. For those whose cottage has skyrocketed in value it pays to be aware that the inclusion rate will increase to 66.7% for those realizing more than $250,000 in annual capital gains. Gains below this threshold remains at 50%.
Before the pandemic, it was uncommon for people to rent out their cottages, but with all flights grounded, cottages became popular short-term rentals. And the trend is as strong as ever today. But potential cottage purchasers should consider it is important to buy a cottage in the right place. Although cottages are most popular in the summer, certain places that offer year-round activities will yield cottage owners even better returns on their investment.
Canadians are already jumping headlong back into the recreational housing market. Royal LePage anticipates 8% growth in the single-family recreational home market in 2024 in Ontario alone, and 5% nationally, which would bring average prices to $662,148 and $678,930, respectively.
Before you jump in to the cottage market, be sure to consult your trusted advisor.
