Selling or transferring an inherited cottage in Canada often triggers capital gains tax, even though Canada does not have an inheritance tax. In most cases, the tax arises either at death through a deemed disposition or later when the cottage is sold. Executors and beneficiaries are frequently surprised by the size of the tax bill, especially when the property has been owned for decades.
This 2026 guide explains how capital gains on inherited cottages work in Canada, how adjusted cost base is determined, when the principal residence exemption may apply, and how to reduce CRA audit risk through proper documentation and planning.
Key Takeaways at a Glance
- Canada does not charge inheritance tax, but capital gains tax often applies
- A deemed disposition occurs at death based on fair market value
- Adjusted cost base is usually reset to fair market value at inheritance
- Capital improvements increase ACB, routine maintenance does not
- The principal residence exemption may reduce tax if designated correctly
- Professional appraisals and records are critical for CRA support
Who This Guide Is For
This article is intended for:
- Executors managing an estate that includes a cottage or vacation property
- Beneficiaries who have inherited a cottage and are considering a sale
- Families planning for intergenerational cottage transfers in Ontario
If you are administering an estate or planning a future transfer, early tax clarity can prevent costly mistakes later.
Capital Gains Rules for Inherited Cottages in 2026
For the 2026 tax year, capital gains in Canada continue to follow the long-standing 50 percent inclusion rate. This means only half of a realized capital gain is included in taxable income for individuals, corporations, and trusts.
This confirmation matters. In 2024, the federal government proposed changes to the capital gains inclusion rate, creating uncertainty for estate planning. Those proposals were cancelled in March 2025. As a result, inherited cottage planning in 2026 proceeds under the traditional framework.
Executors should be cautious when reviewing outdated articles or assumptions that reference higher inclusion rates.
What Happens at Death: Deemed Disposition Explained
When someone dies, the Canada Revenue Agency treats most capital property as if it were sold immediately before death at fair market value. This is called a deemed disposition.
Does capital gains tax apply at death?
Yes. If no spousal rollover applies, the resulting capital gain must be reported on the deceased person’s final tax return.
If the cottage transfers to a surviving spouse or qualifying spousal trust, a rollover may apply and defer the tax until a later disposition.
Important points to understand:
- The estate acquires the cottage at fair market value on the date of death
- That value becomes the new adjusted cost base
- Future gains are measured from that value, not the original purchase price
How Adjusted Cost Base Is Determined for an Inherited Cottage
ACB for Inherited Property
For inherited property, the adjusted cost base is generally the fair market value immediately before death. This applies even if the cottage was originally purchased decades earlier.
When the Original Purchase Price Is Unknown
If records from prior generations no longer exist, the original purchase price does not matter after inheritance. What matters is the supported fair market value at the date of death of the person from whom it was inherited.
Properties inherited before 1972 may be subject to transitional rules. Professional advice is strongly recommended in those cases.
Capital Improvements That Increase ACB
Adjusted cost base can be increased by capital improvements, including:
- Structural additions or extensions
- New roofs, decks, or boathouses
- Major renovations that extend useful life
Routine maintenance such as painting, repairs, etc does not increase ACB.
What If Receipts Are Missing
CRA may accept alternative documentation when receipts are unavailable, including:
- Bank or credit card statements
- Municipal permits or inspection records
- Photographs showing before and after work
- Written confirmations from contractors
The burden of proof remains with the taxpayer. Unsupported ACB increases are commonly denied during reviews.
How Capital Gains Are Calculated on an Inherited Cottage
The basic calculation is:
Capital gain = sale proceeds minus adjusted cost base minus selling costs
Selling costs may include legal fees, real estate commissions, and advertising expenses.
Fifty percent of the resulting gain is taxable and reported on line 12700 of the T1 return.
Example
- Fair market value at date of death: $600,000
- Adjusted cost base: $600,000
- Sale price five years later: $750,000
- Selling costs: $30,000
Capital gain: $120,000
Taxable capital gain: $60,000
Using the Principal Residence Exemption for a Cottage
A cottage can qualify as a principal residence if it was ordinarily inhabited during the year by the taxpayer or a family member. Only one property per family unit per year may be designated after 1981.
Can a cottage be a principal residence?
Yes, but designating it often means the family home cannot be designated for the same years.
Key considerations:
- Designation decisions significantly affect tax outcomes
- Partial designation is possible
- Proper reporting is required to claim the exemption
Common Situations That Create Confusion
- Multiple inheritances: Each deemed disposition resets ACB to fair market value
- Joint ownership: Each owner reports their proportional share of the gain
- Partial sales: ACB must be allocated between land sold and land retained
Action Items for Executors and Heirs
- Obtain a professional appraisal for date of death value
- Gather evidence of capital improvements
- Review of historical principal residence designations
- Confirm ownership structure and percentages
- Retain all sale-related documentation
A Real-World Example: John and the Family Cottage
John became executor of his father’s estate, which included a cottage held for generations. While there was no inheritance tax, the cottage was subject to a deemed disposition on his father’s final return. Because no spousal rollover applied, the capital gain became immediately taxable.
John reconstructed the adjusted cost base using bank statements, photographs, contractor confirmations, and a professional appraisal. He also confirmed that the family home, not the cottage, had been designated as the principal residence in prior years. As a result, the full gain remained taxable.
The experience reinforced the importance of early planning, accurate records, and professional guidance when a cottage forms part of an estate.
Advanced Planning Considerations for Families
Cottages are often retained for emotional reasons rather than financial ones. Without planning, capital gains tax can force a sale during emotionally difficult times.
Common planning gaps include:
- Failing to model tax exposure before death
- Underestimating liquidity needs
- Ignoring potential family disputes
In Ontario estates, early modeling often determines whether a cottage can realistically remain in the family.
Principal Residence Planning Scenarios
Scenario One: City home designated every year
The cottage receives no exemption, and the full gain is taxable.
Scenario Two: Mixed designation
Part of the gain may be exempt, requiring a detailed review of usage and filings.
Scenario Three: Cottage designated for most years
This can reduce cottage tax but may increase tax on the city property later.
Additional Capital Gains Planning Tools
Prior Capital Gains Elections
Historic elections such as the 1994 capital gains election can affect current ACB calculations. Executors should confirm whether any elections were filed.
Use of Trusts
Trusts may offer governance benefits but introduce complexity, including trust tax rates and reporting obligations.
Insurance as a Funding Strategy
Life insurance is commonly used to fund capital gains tax at death, allowing heirs to retain the cottage without selling.
CRA Audit Risk and Documentation Standards
Cottages are frequently reviewed by CRA due to valuation challenges and incomplete records. Long-held properties face higher scrutiny.
CRA commonly reviews:
- Fair market value at date of death
- Classification of capital improvements
- Principal residence designations
- ACB allocation in partial sales
Professional appraisals and organized records significantly reduce audit exposure.
Expanded Executor Responsibilities
Executors must ensure valuations are reasonable, elections are properly filed, and records are retained. Clear communication with beneficiaries helps prevent disputes and misunderstandings.
Frequently Asked Questions
Is there inheritance tax on a cottage in Canada?
No. Capital gains tax applies through a deemed disposition at death.
Can I use the principal residence exemption after inheriting a cottage?
Yes, but only for qualifying years that are properly designated.
What if the estate cannot pay the tax?
Assets may need to be sold, which is why advance planning is critical.
2026-Specific Planning Considerations
In 2026, CRA continues to focus on valuation accuracy, ACB support, and proper reporting of deemed dispositions. Executors filing final returns should expect questions where documentation is weak or values appear aggressive.
Final Takeaways for Inherited Cottage Tax Planning in 2026
Disposing of an inherited cottage in Canada involves more than a simple sale calculation. Capital gains tax, adjusted cost base documentation, and principal residence decisions interact in ways that can materially affect outcomes.
Families and executors who plan early, document thoroughly, and seek professional advice are best positioned to protect both financial value and family relationships.
Ready to Reduce Tax and Avoid CRA Issues?
A personalized review can materially change the outcome of an inherited cottage transaction. Our Ottawa-based CPAs regularly assist executors and families with capital gains planning, principal residence strategies, and CRA compliance.
