Being a homeowner is a Canadian dream. However, you may want to sell your home for a bigger one or another. Given the rate at which property prices surged in the last 10-12 years, there is a likelihood of significant appreciation of the property value. And you have to report the sale in your personal income tax returns. Thankfully, Canada’s Income Tax Act (ITA) exempts tax on the sale of residence under the Principal Residence Exemption (PRE). But you have to claim this exemption.
When you sell a property, the difference between the selling price (fair market value) and the buying price is reported as capital gain and 50% of this gain is added to the income tax if the capital gain is up to $250,000. A 66.6% gain is included in the income tax for any gain above this. However, PRE frees you from this capital gain tax if the property sold qualifies as a principal residence.
Does Your Property Qualify for Principal Residence Exemption?
According to the CRA, a principal residence should be a housing unit such as an apartment or condo. Even a cottage located outside of Canada can be a principal residence. The condition is that the housing unit should be ordinarily inhabited at some point within the calendar year you claim it as a principal residence. But you and your family must have lived on the property.
Period of inhabiting the home: The CRA does not specify how long you should live in the property. This rule aims to identify people who buy properties purely for investments, hold them for a short period, and sell them for a gain. So, the CRA might look at the period you held the property, your real estate buying patterns and sources of income to differentiate homeowners from property flippers, who have to claim the sales proceeds as business income or capital gains.
Size of the property: The CRA has also set 1.5 hectares (roughly 1.2 acres) as the land size that qualifies for PRE. If you sell a 2-hectare farm and home, only 1.5 hectares will be eligible for the PRE, and you will have to report and pay capital gain tax on the other 0.5 hectares.
Multiple properties: If you own multiple properties, you can designate the one with the highest capital appreciation as your principal residence and make the most of the PRE. A family (spouse or common-law partner and children under 18) can designate only one property per year as a principal residence. You can claim an exemption for only the years you have designated the property as a principal residence.
Income-generating property: If you earn income by occupying one room and renting out the other or are using the property solely for renting out for long—or short-term, it may not qualify as your principal residence. However, if you rent the cottage for a few weeks while on vacation and occupy it for the remaining days, it qualifies for PRE.
How Does Principal Residence Exemption Work?
Single property: Identifying a principal residence is easy if you have only owned one house. For instance, John purchased an apartment in 2000 for $200,000; in 24 years, its value has increased to $600,000. Since he only had one property, his $400,000 capital gain is exempt under PRE.
John will have to report to the CRA the sale of a principal residence on Schedule 3 of the T1 Tax Return to claim the PRE benefits. He should also keep some documents that prove that the property was his principal residence all these years. These include records where your address is mentioned, like your driver’s license, provincial or territorial health-care card, vehicle registration, utility bills, property tax receipts, and home insurance. Additional proof could be daily life details like employment records, children’s school enrollment documents, or a history of local purchases.
You need not submit these documents with the tax return but keep them handy if the CRA asks for documentary proof.
Multiple properties: However, things get complicated with various properties. For instance, Michael purchased a property worth $150,000 in 2010. In 2016, he got married and shifted to his spouse’s house, which he termed his permanent residence. He did not rent the first property and sold it in 2021 for $350,000.
Total capital gain = $200,000
The property will qualify as PRE for the first six years = $120,000
Capital gains will apply to four years it was not a PRE = $80,000
Change in use of principal residence: In the above example, if Michael starts renting out his first property in 2016 instead of keeping it vacant, the use changes from principal residence to income generation.
In this case, the CRA will consider a deemed disposition of the property at fair market value in 2016 ($250,000) and repurchase it to earn rent. The new adjusted cost base of the property is $250,000, and any capital gain will be counted from this base. The tax implications will also change.
Contact Edelkoort Smethurst CPAs LLP in Burlington to Help You with the Taxation of Property Transactions
We have just touched upon the PRE. The exemption has various exceptions and conditions, and the tax implication will depend on your situation. A skilled tax advisor can help you understand the tax implications in the sale of property or change in use of the property. He/she can also guide you on tax-effective ways to conduct your property deals. To learn more about how Edelkoort Smethurst CPAs LLP can provide you with the best tax planning expertise, contact us online or by telephone at 905-517-2297.