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Lane
Lane, JD, CFP, MBA, CRPS
Category: Canada Tax
Satisfied Customers: 10104
Experience:  Providing financial and tax advice for 30 years
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We built a cottage 50 miles from our town. It took us close

Customer Question

We built a cottage 50 miles from our town. It took us close to ten years to build and we used a lot of used materials like the windows from our house, the doors. We lost most of our bills threw the years or they faded. We sold the cottage last July 2015. What do I need to do to file our income tax and try to minimise Capital Gain?
Submitted: 8 months ago.
Category: Canada Tax
Expert:  Phillip B, EA replied 8 months ago.

Thanks for using JustAnswer.com! I will do my best to provide you with a clear and concise answer to your tax question based on the information you have provided.

Your situation falls under a famous court ruling called the Cohan Rule. The case (Cohan v Commissioner, 39 F. 2d 540 (2d Cir. 1930)) involved a theater owner who was audited by the IRS after his theater and all his records were destroyed in a fire. The IRS refused to allow undocumented estimates for deductions. He sued and the courts ruled that "when unable to produce records of actual expenditures, (the IRS) may rely on reasonable estimates provided there is some factual basis for it."

So, the issue for you is coming up with a "factual basis" for your estimates. The best (I would think) you are going to be able to do is find property tax appraisals (from the county tax assessor where the property is located) from the time the property was finished, this would give you a factual basis for what your cabin would have been worth at the time you completed the home. That would be an estimate with a factual basis that I would feel comfortable using as the basis on your return.

Be advised, if you do use an estimate, you should also file form 8275 with the return to disclose the estimate in order to keep you safe from penalties if the IRS audited the return and disallowed your estimate later on.

If there are additional questions or concerns, please reply to this answer so that I may assist you further. If this answers your question, please rate my performance between 3 and 5 stars so that I am credited for my work. Thanks for your business

Customer: replied 8 months ago.
Do you need to fill out the estimate form 8275 if you live in Canada? If yes, could you send me a copy of this file?
Expert:  Phillip B, EA replied 8 months ago.

Oh dear. I missed the Canada line in the country box. Forgive me, I don't know if Canada has a similar rule. I will opt out.

Expert:  Lane replied 8 months ago.

Hi - I can help here ... CRA, especially in the sale of cottages that are not the primary residence DOES focus on documentation of your ACB (Adjusted Cost Base) the the logic that applies in the Cohen case mentioned above applies in all common law based tax law.

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Although receipts are Ideal, reasonable estimates are allowed, ESPECIALLY if you can show like-kind sales prices for cottages in the same region around the time you completed the work. (This is exactly what an appraiser does, compare like kind values then reduce to a square footage, and apply that that to the square footage of your cabin)

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Also valuable here would be the use of (1) the property value of the land of course, then (2) a list of the materials used ... given that you did this yourself, I'd bet that you can put together a list of the materials and estimate their prices based on when you bought them ... discussions with suppliers about how prices have changed on those items over the course of the years would be beneficial ... Having this logged in writing is MUCH better than simply conveying that verbally, should CRA audit the return.

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Here's an excellent checklist that might help:

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Checklist of cottage ACB components and required documentation​

R Original acquisition of the property

Elements from the Purchase Agreement and other costs (documented by invoices,statements and proof of payment) include:

  • Purchase price of the cottage, if purchased after 1971 (contact your BDO advisor for properties owned on December 31, 1971, or if you made an election in 1994 to increase the ACB)
  • If inherited or received as a gift, evidence of the value at the time of the gift or inheritance such as a valuation
  • Land transfer taxes on acquisitionUtility connection costs
  • Real estate commissions
  • Real estate inspections
  • Legal fees
  • Cost of a survey or title insurance
  • Other purchase agreement disbursements, other than reimbursements to the former owner for annual costs such as property taxes and utilities that were paid before closing
  • Repairs and maintenance related to properties acquired in a state of disrepair. Generally speaking, it may be possible to include costs that wouldn’t ordinarily qualify in the opening ACB such as costs related to replacing a roof, buying new fixtures and plumbing, replacing flooring, etc. The key is that the state of disrepair was factored into the purchase price (i.e. the price would have been higher if the cottage was in better shape and these costs were incurred for that reason).

R Improvements not directly related to the building

Make sure you include any improvements to the land that are not related to maintaining current elements. Costs could include a new septic system, a new well, a water system etc. Also, ensure that you include any improvements to the land such as correcting drainage problems, building a driveway or right of way, pathways or fixed decks and docks. Moveable items will generally not qualify (although the definition of moveable should be carefully considered from a practical perspective). Documentation needed includes invoices and proof of payment.

R Renovations

Any change to the structure of a cottage that creates something that wasn’t present before will generally qualify as an addition to ACB. Documentation will include invoices (including details on the nature of the work as an improvement) and proof of payment. Examples include:

  • Adding new rooms or finishing a basement
  • Building a new deck or replacing an old deck with a larger deck
  • Moving walls or partitions inside the structure
  • Creating a new bathroom, including the cost of fixtures

R Ongoing maintenance vs. building improvements

Probably the most difficult task is deciding whether repairs and maintenance costs are an ACB addition or just an ongoing expense that cannot be included in ACB. Generally, the test is whether the structure has been improved vs. just returned to a previous state of repair during your period of ownership. A good example is a new roof. If the cottage’s roof was in good shape when you acquired the cottage, then there is a strong argument that just replacing the shingles is an ongoing cost. However, if you replace a roof with a different and higher quality type of roofing, then that cost could be an ACB addition. A key element to consider, in addition to having documentation similar to that described so far, will be whether the documentation highlights why an improvement was made. Other examples where an improvement may have been made include:

  • New windows and doors
  • New flooring and paneling
  • Replacing bathroom or kitchen fixtures

A final note for those do-it-yourself (DIY) cottagers — you can’t capitalize the imputed cost of your own labour for a DIY improvement, but you can capitalize the cost of the materials you used for the improvement.

Expert:  Lane replied 8 months ago.

Without a doubt, CRA has been known to audit gains on second residences.

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The sale price won't be the issue if the sale was an arms length sale to an unrelated party.

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But on additions, the CRA will be looking for proof of the expense and why it is not a regular repair or maintenance cost.

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The more re-creation of expenses (actual or estimates from third parties) you have, in a tangible, written form, the better.

Expert:  Lane replied 8 months ago.

And of course this is only needed in the event of what CRA calls an information request (what many call an audit). But hopefully working through the process of documenting this will help you to be more confident of your ACB calculation and prepared should an information request ensue.

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By the way, I do NOT buy the idea that CRA will value an appraisal of for purposes of ACB. I MAY be a way indirectly to support your calculation. But ACB (Adjusted Cost base) is about what YOU have invested in the property, not what it may have sold for at the time you completed the work.

Expert:  Lane replied 8 months ago.

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I hope this has helped.

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Please let me know if you have any questions at all.

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If this HAS helped, and you DON’T have other questions … I'd really appreciate a positive rating (using the rating request, faces, or stars on your screen)

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That's the only way I'll be credited for the work here.

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Thank you!

Lane

Expert:  Lane replied 8 months ago.

Hi,

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I’m just checking back in to see how things are going.

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Did my answer help?

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Let me know…

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Thanks

Lane

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