Every individual dream of buying a house. The government wants to help Canadians buy their home by offering several incentives to home buyers. One such effort was proposed in Budget 202  to create the tax-free First Home Savings Account (FHSA). If the bill is passed, the FHSA rules will be effective from April 1, 2023.

Until then, you can learn more about the new FHSA. In this article, we will discuss what the Canada Revenue Agency (CRA) has so far disclosed about FHSA and how it can help you reduce your tax.

Know Your First Home Savings Account

The FHSA aims to help Canadian residents save for the down payment of their first home without paying any tax. Hence, the CRA created FHSA by combining the benefits of a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA). The FHSA allows eligible first-time home buyers to contribute $40,000 in a lifetime (15 years), with a maximum annual contribution of $8,000. Any excess contributions are taxable at 1%.

Like RRSP and TFSA, you can invest FHSA money in mutual funds, publicly traded securities, government and corporate bonds, and guaranteed investment certificates. However, you cannot invest in assets such as land, private company shares and general partnership units.

Unlike RRSP (withdrawals are taxable) and TFSA (contributions are taxable), FHSA contributions and qualifying withdrawals (to buy your first home) are tax-free. It means you can invest up to $8,000 in FHSA in a financial year and deduct it from your taxable income. If you make a qualifying withdrawal, there is no need to report the withdrawal in your taxable income.

How Does First Home Savings Account Work?

If the FHSA comes into effect, the CRA will allow Canada’s residents above 18 years of age to open an FHSA and invest $0-$8,000 annually up to $40,000 in 15 years or age 71 (whichever is early). To open an FHSA, you have to qualify as a first-home buyer. It means you, your spouse or common-law partner, should not own the home you live in the year you opened the FHSA or the preceding four calendar years.

When you confirm your eligibility, the financial institution will open your FHSA and file your annual information returns to the CRA. You can have more than one FHSA, but your combined lifetime contribution limit will remain $40,000. After you have accumulated enough money and finalized a home, you can withdraw your FHSA tax-free to help you buy your first home.

To make a qualifying tax-free withdrawal, you should withdraw within 30 days of moving into a qualifying home. The CRA defines a qualifying home as one in Canada that you intend to use as a primary residence within a year of buying/building the house. You should have a written agreement to buy or build a qualifying home before October 1 of the withdrawal year.

Once you are eligible for withdrawal, submit a request to your FHSA issuer, who will state the withdrawal amount in an information slip and provide the funds. You don’t have to report the withdrawal amount in your taxable income. You can transfer any unused FHSA amount to your RRSP or registered retirement income fund (RRIF) tax-free by December 31 of the following year.

If the FHSA amount is unused after 15 years of opening the account or at age 71 (whichever is early), the account will lose the FHSA status, and the CRA will tax the unused amount.

How to Make the Most of FHSA/TFSA/RRSP Tax Benefits

FHSA’s advantage is its tax-free contributions and withdrawals. How to make the most of it? If FHSA comes into effect, you can invest up to $8,000 annually and claim a tax deduction. It is over and above your RRSP contribution.

You can directly add money to your FHSA or transfer money from RRSP/TFSA to your FHSA. For instance, Amy has $7,000 to contribute to a registered savings account. She has already invested $6,000 in TFSA and can’t claim tax deductions on it. She can transfer that amount to RRSP and make her TFSA contribution tax-free. In both accounts, her investment can grow tax-free. After seven years, her FHSA amount increases to $80,000. She can withdraw the entire portfolio value tax-free to buy a home.

Amy can also combine the $40,000 FHSA limit with RRSP’s $35,000 Home Buyers’ Plan (HBP) limit to make the down payment for her first home (as per November 2022 amendment). Even HBP allows tax-free withdrawal for home buying, but she will have to repay the RRSP withdrawals within 15 years.

After considering the tax implications of all three accounts, Amy can prioritize saving for her first home in the following order:

• First, exhaust the FHSA limit and claim a tax deduction (she can carry the tax deduction to a later year).
• Second, exhaust the RRSP HBP limit as she will have to repay this amount.
• Lastly, exhaust the TFSA limit as she cannot deduct contributions from taxable income.

Continuing the above example, Amy contributes $7,000 in FHSA towards home buying, but her taxable income is $5,000. That year, she deducted $5,000 in FHSA contributions, making her taxable income zero and carrying forward the remaining $2,000 deduction to the next year. These tax savings help Amy invest more in HBP and TFSA, accelerating her goal to buy a qualified house.

FHSA Rules for Over-Contribution

While you can make the most of FHSA contributions to reduce tax, over-contributions will attract a 1% tax. You can withdraw the excess contribution (taxable or tax-free) or transfer it to RRSP tax-free or pay 1% tax and reduce your next year’s FHSA contribution by the excess amount.

For instance, Joey contributes $9,000 to FHSA. He uses the most tax-efficient way and transfers the $1,000 excess contribution in FHSA to RRSP tax-free. If he failed to act, he would face a $10 tax (1% on the $1,000 excess contribution) and would reduce next year’s FHSA contribution to $7,000 ($8,000-$1,000).

There are many more FHSA benefits. For instance, it can be a tax-efficient way to transfer savings to your spouse in case of the account holder’s death. A tax expert can help you understand all permutations and combinations to leverage these registered savings accounts.

Please note the above FHSA rules are a draft and can change when the bill is passed.

Contact Edelkoort Smethurst CPAs LLP in Burlington to Help You Buy Home Tax Efficiently

Talk to a tax expert to help you stay updated with the new accounts and tax deductions. At Edelkoort Smethurst CPAs LLP, our accountants and tax experts can guide you on taking advantage of the CRA’s deductions and making the most of your savings. To learn more about how Edelkoort Smethurst CPAs LLP can provide you with the best accounting and tax-saving expertise, contact us online or by telephone at 905-517-2297.