What makes a house a home is your loved ones. The Canada Revenue Agency (CRA) takes this seriously when determining tax treatment of a property sale. The CRA allows any gain on the sale of a principal residence (the house where you live with your spouse and children) to be exempt from capital gain tax. This exemption can save you a significant amount in tax, given that benchmark house prices in Canada more than doubled over the past decade.
Principal Residence Exemption (PRE) intends to encourage Canadians to purchase houses for themselves and their families, but not everyone uses it for that purpose. House flippers (who buy property, refurnish it, and sell it for a higher price) used this exemption to make money.
Hence, the CRA became stricter about what qualifies as a principal residence and imposed capital gains tax on the sale of those properties they were not convinced were primary residences. The definition of primary residence remains vague and could change with the situation. In this article, we will try to understand the basis the CRA uses when qualifying a sale under the PRE.
What Is Principal Residence?
The CRA determines principal residence as
- A housing unit like an apartment, cottage, condominium, trailer, or mobile home situated on the land of a one-half hectare or less owned solely by you or jointly with your spouse or common-law partner.
- a property you claim principal residence and have ordinarily inhabited during that financial year.
- Ordinarily inhabited means you have or are living in the house alone or with a current or former spouse, common-law partner, or children.
While the definition might look simple, situations complicate things and make you wonder if your house qualifies as a principal residence.
Does Your Property Qualify as Principal Residence?
Qualifying principal residence is simple when your family owns only one house, which you sell to buy another. But it gets complicated with situations. We have listed a few scenarios where qualifying property as a principal residence is twisted.
Scenario 1: Owning A Housing Unit More Than 1/2 Hectare
Starting with the first point of owning a housing unit, the unit must be within one-half hectare. But if the principal residence is in an area where the occupied land exceeds 1/2 hectare, you have to justify that excess land is for use and enjoyment as a residence and not to earn income.
For instance, a country house uses the excess land to keep pets for country living or to build a path to access the highway. If you have a horse stable within the premises that you use to earn income, that portion must be excluded from the principal residency.
Scenario 2: Ordinarily Inhabited During the Financial Year
The CRA says that you should have lived or been living at the property during the financial year you claim for principal residence exemption. But it does not specify the number of days. It means you don’t have to live in the residence full-time. You can rent it out on platforms like Airbnb for a brief period while on vacation. If your rented days are less than your own residency, and you can establish that the main purpose of the house was to live in it alone or with your family, it can be considered a principal residence.
The CRA might investigate your PRE claim to check for personal occupancy. You can prove that with the following documents:
- Utility bills under your name
- The number of days the property was rented and used for self-occupancy.
- Rental income and capital gains earned on the sale of the property.
- Your real estate transaction history and other sources of income.
The CRA will review these documents to see how frequently you rent, buy, and sell a house and how much you earn from all income sources. If the CRA finds that your rental income and capital gain are frequent and form a major portion of your total income, it may not consider the property a principal residence.
Scenario 3: Ordinarily Inhibited by Parents or Children
When the CRA says “ordinarily inhabited,” it doesn’t mean you have to live in the house. The main objective was to provide a home for yourself or your family. If children move into their parent’s house while the parents go off to live in a senior facility, the property qualifies as principal residency. If the parent sells or transfers the property (deemed disposition on death), they can claim the PRE.
However, if the child is the property owner and the elderly parent is living in the house, it does not qualify as ordinarily inhabited. Hence, the child cannot claim the PRE.
Scenario 4: Ordinarily Inhibited by Former or Current Spouse
Other than parents and children, the occupancy of spouses or common-law partners is also complex. If there is a relationship breakdown, separation, or divorce, they cannot claim separate principal residences immediately.
The CRA will not consider two different houses as principal residences for the separating spouses or common-law partners unless they have been living apart for a full calendar year, separated judicially or under a written separation agreement.
Situations Where Things Get Complicated
The above scenarios still have clarity. Things get complicated when you own multiple properties. The PRE applies to the years the property was owned and the years it was ordinarily inhibited. You can only claim one property as principal residence per tax year. What it means?
For instance, you own Property A between 2015 and 2023 and Property B between 2019 and 2023. Both qualify for principal residence. If you sell property A, you can claim PRE on it for tax years 2019-2023. If you sell property B in 2024, you can only claim PRE for 2024.
Contact Edelkoort Smethurst CPAs LLP in Burlington to Help You with Real Estate Transactions
Real estate transactions and their taxation can get very complex depending on the situation. A professional tax consultant can analyze your situation and determine the taxes that apply and the ones that don’t. If you receive an inquiry from the CRA, a skilled tax expert is qualified to prove your eligibility. To learn more about how Edelkoort Smethurst CPAs LLP can provide you with taxations of real estate transactions, contact us online or by telephone at 905-517-2297.