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Tag: second property

  • Is a vacation home a good investment? – MoneySense

    Is a vacation home a good investment? – MoneySense

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    Sometimes, emotions are the motivation for buying a vacation property. I like to evaluate a property purchase from a financial point of view as well—and here’s how. 

    The costs of buying a vacation property

    Say, a property’s purchase price is $500,000. Whether you use cash, a mortgage/home equity line of credit, or a combination of the two, there are other costs to consider.

    If you purchase with cash that you could otherwise invest for a 4.5% return (to use a conservative assumption), there is an opportunity cost of not investing that money or leaving it invested. If you borrow money, there may be an interest cost of 4.5%. So, to keep it simple, we will assume an opportunity cost or financing cost of 4.5%. 

    Property taxes, utilities, insurance, condo fees, and maintenance could easily add another 2% to 4% per year in costs. Those costs could be even higher for an older cottage or for a property with amenities and high fees, but we will assume 3% per year for discussion purposes.

    So far, our costs are up to 7.5% per year on a $500,000 property, which works out to $37,500 per year for our notional vacation property. 

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    Expected returns on vacation properties

    What about the financial return from owning the property? Canadian real estate prices have risen by about 6.3% per year for the 10 years, ending Dec. 31, 2023. Over the past 30 years, the increase is about 5.1%. Some cities have seen much higher growth rates, and others much lower. Prices have also cooled off significantly in the past couple of years. (Check out MoneySense’s guide on where to buy real estate in Canada.)

    Over the long run, in the U.S., real estate prices have risen just slightly more than inflation. In fact, since 1890, U.S. real estate has increased by less than 0.6% per year above the rate of inflation. Given the Bank of Canada’s 2% inflation target, despite a recent spike in the cost of living, I would argue a more reasonable long-term growth rate for real estate is 2% to 3%.

    So, we will assume the value of our notional $500,000 property grows at 3% per year; in the first year, that would be $15,000. That means the net cost in year one of owning the property is 7.5% (or $37,500) minus 3% (or $15,000), totalling 4.5% (or $22,500).

    Buying versus renting a vacation home 

    If you are contemplating a $500,000 vacation property purchase, and you think my assumptions are reasonable, you need to ask yourself: Are you going to get $22,500 worth of use out of the property? Could you rent a comparable property for less than $22,500 per year, for the time you plan to use it? If you could, a vacation property purchase may not be the best financial choice.

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    Jason Heath, CFP

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  • When are costs for a U.S. property tax-deductible in Canada? – MoneySense

    When are costs for a U.S. property tax-deductible in Canada? – MoneySense

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    It sounds like you sold or are planning to sell a property in the U.S., Bob. To cut to the chase, selling costs, like a realtor commission, would be deductible on your Canadian tax return.

    This assumes the property is taxable, which is typically the case for a foreign property. Interestingly, a property outside Canada can qualify as your principal residence. But this would be unusual for a Canadian resident, whose Canadian home would typically be more valuable than a foreign one, and therefore, more appealing to claim as your principal residence.

    Do you have to report the sale in Canada?

    Assuming the property in question is a vacation or rental property, the sale would be reported on your Canadian tax return. In addition to your selling costs, Bob, your acquisition costs, including legal fees, renovations or improvements, can reduce your capital gain.

    Your capital gain would be calculated based on your net sale proceeds minus the acquisition cost, including renovations. You have to convert these amounts from U.S. dollars to Canadian dollars based on the applicable exchange rates.

    The Canada Revenue Agency (CRA) says you should report foreign income or expenses based on the Bank of Canada exchange rate on the date of the transaction. It will accept a different rate for the transaction date if the source is:

    • Widely available
    • Verifiable
    • Published by an independent provider on an ongoing basis
    • Recognized by the market
    • Used in accordance with well-accepted business principles
    • Used to prepare financial statements (if any)
    • Used regularly from year to year 

    Bloomberg L.P., Thomson Reuters Corporation, and OANDA Corporation meet these criteria and are “generally acceptable” to use, according to the CRA.

    U.S. tax implications of selling property in the U.S.

    The U.S. property sale will also have U.S. tax implications, even if you’re not a U.S. citizen. When a Canadian sells real estate in the U.S., they must file a U.S. tax return with U.S. capital gains tax potentially payable. This is a common requirement in other countries as well.

    The U.S. tax paid can qualify as a foreign tax credit to reduce your Canadian tax payable, Bob, to avoid double taxation.

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    Jason Heath, CFP

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  • How to carry back a capital loss for a tax refund – MoneySense

    How to carry back a capital loss for a tax refund – MoneySense

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    It sounds like you are aware that you can carry back capital losses, Ramesh. If you have a net capital loss on your 2023 tax return, you can carry it back up to three years. So, you can ask the Canada Revenue Agency (CRA) to apply that loss to capital gains you had in 2022, 2021 or 2020.

    When should you carry back a capital loss?

    You can apply some or all of the loss to one or more of those years. If you had capital gains in more than one of the past three years, there are three primary considerations.

    1. 2023 is the final year you can carry back losses to 2020. In 2024, the furthest you can carry back a capital loss is 2021.

    2. If you had a high income in one of those three years, you might be better off carrying the loss back to the year with the highest income. That way, you can maximize the resulting tax refund.

    3. If your income and tax rate were relatively low in one or more of the past three years, you might want to defer claiming the loss. Capital losses can be carried forward indefinitely to use against capital gains in a future higher-income tax year.

    You are not restricted, Ramesh, to claiming a capital loss on securities against a capital gain on securities. So, in your case, you could carry back a capital loss on securities to claim against a previous capital gain on a rental property.

    How to carry back a capital loss

    In order to carry back a capital loss, you have to complete Section III – Net capital loss for carryback on Form T1A, Request for Loss Carryback on your tax return. Although it can be printed, filled out and submitted to the CRA, a taxpayer or their accountant would generally submit the form as part of their annual tax filing.

    After your tax return for the current year is assessed, you will later receive a notice of reassessment from the CRA with a tax refund for a previous year, if applicable.

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    Jason Heath, CFP

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  • How to use equity to buy a second home – MoneySense

    How to use equity to buy a second home – MoneySense

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    “Potential buyers may not have the cash they require to pay for an asset like a second home in part or in full,” says Maxine Crawford, a mortgage broker with Premiere Mortgage Centre in Toronto. “They may have their money tied up in investments that they cannot or do not want to cash in. By using home equity, however, a buyer can leverage an existing asset in order to purchase in part or in full another significant asset, such as a cottage.”  

    What is home equity?

    Home equity is the difference between the current value of your home and the balance on your mortgage. It refers to the portion of your home’s value that you actually own. 

    You can calculate the equity you have in your home by subtracting what you still owe on your mortgage from the property’s current market value. For example, if your home has an appraised value of $800,000 and you have $300,000 remaining on your mortgage, you have $500,000 in home equity. If you’ve already paid off your mortgage in full, then your home equity is equal to the current market value of the home. 

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    What is a home equity loan?

    A home equity loan (sometimes called a second mortgage) is when a home owner borrows money using the equity they’ve built up in their home as collateral for the new loan. Equity is the difference between the current market value of the property and the balance owing on the mortgage. Typically, home owners can borrow up to 80% of their property’s value, including any balance remaining on the first mortgage.

    How to use equity to buy a second home

    To buy a second property using home equity, you borrow money from a lender against the equity—meaning you use the equity as leverage or collateral. There are a variety of ways a home owner can do this.

    Mortgage refinance: When you refinance your mortgage, you replace your existing mortgage with a new one on different terms, either with your current lender or with a different one (when switching lenders, you may have to pay a prepayment fee, unless your mortgage was up for renewal). When refinancing, you can get a mortgage for up to 80% of your home’s value. Refinancing your mortgage allows you to access the capital needed to buy a second home.

    Home Equity Line of Credit (HELOC): A HELOC works like a traditional line of credit, except your home is used as collateral. You can access up to 65% of your home’s value. Interest rates on HELOCs tend to be higher than those on mortgages. However, you only withdraw money when you need it, and you only pay interest on the amount you withdraw, unlike with a second mortgage or reverse mortgage.

    Second mortgage: This is when you take out an additional loan on your property. Typically, you can access up to 80% of your home’s appraised value, minus the balance remaining on your first mortgage. Second mortgages can be harder to get, because if you default on your payments and your home is sold, the second mortgage provider only receives funds after the first mortgage lender has been repaid. To compensate for this added risk to the second lender, interest rates on second mortgages tend to be higher than for first mortgages.

    Reverse mortgage: Only available to home owners who are 55 or older, a reverse mortgage allows you to borrow up to 55% of your home’s equity, depending on your age and the property’s value. Interest rates may be higher than with a traditional mortgage, and the loan must be paid back if you move or die. You don’t need to make any regular payments on a reverse mortgage, but interest continues to accrue until the loan is repaid. 

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    Sandra MacGregor

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  • Second mortgages in Canada: What are the rules? – MoneySense

    Second mortgages in Canada: What are the rules? – MoneySense

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    • How you intend to use the property—i.e., for personal use (such as a second home or cottage) or as a rental or investment property. 
    • Whether or not the property will be owner-occupied—i.e., whether you will be living in the property (alone or with a tenant) or renting out all the units in the building. 

    If the second property is for personal use, such as a vacation property or cottage, you will likely have to meet the same down payment requirements as with your first home. For example, a second home purchased for $800,000 requires a down payment of 5% on the first $500,000, plus 10% on the portion above $500,000. 

    Rentals that are owner-occupied—maybe a home in which the owner lives on the main floor, and a tenant lives in the basement suite—generally are subject to the same rules, says Elan Weintraub, co-founder and mortgage broker with mortgageoutlet.ca. 

    However, if the property will not be occupied by the owner, meaning the entire property will be rented out, Weintraub says you should have a down payment of at least 20%, no matter the price of the home. He adds that certain lenders have different requirements.

    Lenders take the question of owner occupancy seriously, so always be honest about your plans, advises Weintraub. “If you say you will live in the property, then that’s the expectation, and depending on your lender and the mortgage type, you could be in default if you do not live there.” 

    Should you get a mortgage on a second property?

    Managing two mortgages is a big financial commitment, so it’s important to plan ahead and consider seeking expert advice if you’re unsure if you can afford it. 

    Weintraub says there are several key factors to consider before deciding to take on a second property mortgage. These include:

    • Your financial situation: Do you have extra savings in case, say, the roof collapses, the tenant stops paying rent, and so on? Buying a second property could be risky if you’re using your entire savings to make the purchase, leaving no room for unexpected expenses.
    • The time commitment: A second property (especially a cottage and/or rental property) could require a lot of maintenance and attention. Do you have the time to care for the property yourself, or extra money to pay for those services? If not, owning additional real estate may not be something you have time for. 
    • Your income stability: How secure is your job or your business? Are you certain you will have the income needed in the future to continue making payments on two mortgages? If you’re unsure about your ability to make payments in the future, you may not have the financial means of owning multiple properties.
    • Your time horizon: If you’re planning to sell the property in a few years, you may not recoup the costs of your initial investment. There are many upfront costs to account for when buying and selling real estate, including land transfer taxes, realtor fees and legal fees. 

    Second mortgage rates in Canada: What to expect

    Whether you go with the same lender or a different one for your second mortgage, the interest rate will likely be higher than for your first mortgage. That’s because your second mortgage takes second priority: If you foreclose on the home, the debt owed to your first lender must be repaid first. Therefore, your second mortgage provider takes on a greater risk and is compensated for this risk by charging you a higher mortgage rate.  

    Keep in mind that you’ll also have to pay the same administrative costs as with your first mortgage, including things like appraisal and legal fees. Furthermore, Weintraub emphasizes that cash flow should be another consideration. “You would need a strong income to acquire a second property, as you would have significant debt—a mortgage on your primary and secondary residence. A few years ago, rates were 1% to 3%, so it was much easier to borrow money. Today, the mortgage stress test essentially requires the mortgage to be tested at 8% or higher.”

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    Is a second mortgage worth it?

    Getting a mortgage on a second property can help you purchase the perfect cottage hideaway, support your adult children’s housing needs, or become a landlord for the first time. However, second property mortgages aren’t for everyone. Before committing to a second property, understand your financial position and consider speaking to a financial advisor or mortgage broker. 

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    Sandra MacGregor

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  • The tax implications of buying a second home in Canada – MoneySense

    The tax implications of buying a second home in Canada – MoneySense

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    Primary residences vs. secondary properties

    The tax treatment of real estate in Canada depends on its use. The home you live in—your primary residence—is normally exempt from capital gains tax upon sale due to the primary residence exemption.

    This exemption can even be used on vacation properties, so long as it is “ordinarily inhabited.” While the definition of “ordinarily inhabited” is vague, it means at a minimum you spent time living there during a calendar year. And while there’s an exception for years in which you move and own two homes, you can otherwise only declare one property as your primary residence at any given time. Generally speaking, you’ll want to apply the exemption to the property that has increased in value the most.

    Rental properties don’t qualify for this exemption under most circumstances. When they’re sold, if they have increased in value, capital gains taxes will normally apply.

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    Capital gains tax on a second property in Canada

    When selling a property, if you can’t use the primary residence exemption, then capital gains taxes will be levied against the increase in value. But capital gains are relatively tax-efficient, since only half of the gain is taxable—the other half you can stick in your jeans.

    To calculate the capital gain, you need to first calculate the adjusted cost base, or ACB, against which the sale proceeds will be measured. The starting point is the purchase price, and from there certain additions and deductions can be applied. Common additions include expenses incurred to purchase the property, like commissions and legal fees. Capital expenses, like those used to improve or upgrade the property, can also be added.

    Here’s where it gets a little complicated. Because a building is depreciable property which may wear out over time, investors can deduct a percentage of the property’s cost each year—known as “capital cost allowance,” or CCA. It can only be used against the building itself, not the land portion of the property. When the property is eventually disposed of, the undepreciated capital cost, or UCC—that is, the original cost minus the amount of CCA claimed—is recaptured and taxed as income, with additional proceeds being taxed as a capital gain.

    As a simplified example, say you bought a rental property for $1,000,000. Over the years, you deducted $200,000 of CCA. You then sold the property for $1,300,000. Here’s how it would be taxed:

    • Original cost: $1,000,000
    • CCA claimed: $200,000
    • Undepreciated capital cost: $800,000

    When the rental property is sold, that $200,000 CCA is recaptured and taxed as income. And since you sold it for $1,300,000, you have a capital gain of $300,000. Half of this is taxable, so you add $150,000 to your income that year. Between the recapture and the taxable half of the capital gain, you have $350,000 of income to report on your tax return.

    Capital expenses vs. current expenses: What’s the difference?

    In the above example, the cost of improving the property is a capital cost. It extends the useful life of the property or increases its value. Capital expenses can increase the ACB of the property and can be deducted over time via the CCA. Examples include:

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    Mark McGrath, CFP, CIM, CLU

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  • Family legacy: How to pass along the family cottage—and 3 things to avoid – MoneySense

    Family legacy: How to pass along the family cottage—and 3 things to avoid – MoneySense

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    There’s no one-size-fits-all solution. “Planning has a lot of moving pieces, and it’s very important to get it right, and it’s very easy to get wrong,” says Peter Lillico, partner at Lillico Bazuk Galloway Halka Law firm in Peterborough, Ont. He is also a speaker at the Cottage Life shows. “Every family is unique, every cottage is unique, and every cottage succession is unique.” Here, he breaks down the common misconceptions Canadians have about estate planning around the family cottage.

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    Myths around cottage succession 

    Identifying any potential issues is the first step in navigating how to transition the family cottage effectively. Let’s look at some common misconceptions and the solutions that work.

    1. Assuming everybody will get along

    Many parents assume that their children and other family members will agree on how to use and maintain the cottage. This is a mistake because it overlooks the potential for conflicts and differing expectations.

    For example, take a family with two adult children, one living in Alberta and the other in Ontario. The one who lives close to the cottage in Ontario may use the property quite often. However, if the expenses are split 50/50 between both, this can lead to arguments. Lillico says: “There are cottage sharing agreements that can, and should, be worked out beforehand.” Parents (and/or their adult children, frankly) can create agreements that outline rules around care and expenses, and whether they should be shared equally or allocated in proportion to usage, or whatever the family wants. 

    A cottage sharing agreement is a binding document that passes the ownership and control from one generation to the next. It doesn’t just include estate planning details, but also future rules around the cottage. It contains structured instructions for financial responsibilities, sharing usage concerns, division of ongoing labour and maintenance, and even dispute resolution. Lillico explains a real estate lawyer can help with the cottage sharing agreement, as well as “a worksheet that helps [parents] to consider how well suited the kids are for cottage ownership.” 

    2. Underestimating capital gains tax

    Some Canadian cottage owners may believe that succession of the property will leave their children with a valuable asset, but many underestimate the costs of capital gains tax and unforeseen maintenance expenses.

    As real estate prices increased over the years, the family cottage may have risen in value significantly, especially if it was purchased decades ago. This leaves owners facing capital gains tax when they sell the property. Capital gains tax is levied on the profit of the cottage, which is considered a capital asset. 

    Capital gains and losses are calculated based on the difference between the selling price and the original purchase price, adjusted for certain eligible expenses like renovations and improvements. (So, keep those receipts to lower the gain!) 

    A loss can be used to reduce owed taxes on a personal income tax return. A gain, however, is taxed, but not all of it. The taxable portion of a gain is divided in half, and that amount is added to the individual’s overall income and taxed according to their income tax bracket.

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    Debbie Stanley

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  • Down payment for a second home in Canada: How much do you need? – MoneySense

    Down payment for a second home in Canada: How much do you need? – MoneySense

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    So, how much of a down payment do you need for a second home? That depends on a few factors, including whether or not you intend to live at the property. 

    Down payment requirements in Canada

    Every Canadian home buyer is required to have a minimum down payment when purchasing property. A down payment is the money provided up front towards the purchase of the home, and it is directly tied to the value of the property. 

    When buying a home, the down payment rules in Canada are as follows:

    Purchase price Minimum down payment required
    $500,000 or less 5% of the purchase price
    $500,000 to $999,999 5% of the first $500,000 of the purchase price
    +
    10% of the portion of the purchase price above $500,000
    $1 million or more 20% of the purchase price

    If you’re buying a home priced under $1 million and your down payment is less than 20%, you’ll need to purchase mortgage default insurance, also known as mortgage loan insurance—which protects the lender if you can’t make your mortgage payments. Using a mortgage down payment calculator is the fastest and simplest way to figure out how much money you will need for your home down payment.

    Minimum down payment for a second home in Canada

    Contrary to popular belief, there’s no blanket 20% down payment requirement for second-home purchases in Canada. In fact, the down payment rules for a second home are similar to those listed above for single-property ownership, as long as the second home will be owner-occupied, meaning the owner will be living in it. 

    “You can purchase a second home with 5% down as long as the property is intended for family use throughout the year and the mortgage is under $500,000,” says Samantha Brookes, CEO of Toronto-based Mortgages of Canada. 

    The 5% down payment requirement applies to second homes with one or two units in them. For properties with three or four units, the minimum down payment jumps to 10%.

    Buildings with five or more units are considered commercial buildings, and they require a commercial mortgage. Depending on the property’s location and the buyer’s cash flow, lenders may require a buyer to have a down payment of 20% to 35% on commercial properties, according to Brookes. 

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    Sandra MacGregor

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