Income Tax Act s. 40(2)(b)
Principal Residence Exemption (PRE)
When a principal residence is sold, the gain is not taxable if it has been the person's principal residence for the whole time it has been owned. This is because the principal residence exemption eliminates the capital gain. In years prior to 2016, there was no need to report the sale on your tax return if the entire gain was eliminated. However, on October 3, 2016 the federal government announced that, starting with the 2016 tax year, the sale of a principal residence must be reported on Schedule 3 of the tax return, in order to claim the principal residence exemption. This change applies also for deemed dispositions, such as a deemed disposition due to change in use of the property.
Two other major changes to the Income Tax Act (ITA) regarding the reporting of the disposition of a principal residence:
To designate a property as the principal residence, it does not have to be the place where the taxpayer lives all the time. The property will qualify as a principal residence if the taxpayer, taxpayer's spouse or common-law partner, or any of the taxpayer's children lived in it at some time during the year. However, if it is rented out the situation may change. See the information below re change in use.
As mentioned in the March 2016 Life in the Tax Lane video, the principal residence does not have to be located in Canada. They point out that if you purchased a vacation property in the US, then you could designate it as your principal residence for years in which you resided there at some time during the year. Check out the video for more information, as well as the CRA Folio S1-F3-C2: Principal Residence Outside Canada.
A taxpayer and spouse may only designate one principal residence between them for each tax year after 1981. For years prior to 1982, each individual taxpayer can designate one principal residence, so if a couple has owned both a primary home and a cottage for decades, the principal residence exemption is available for both homes for the years prior to 1982.
The increase in value of the home from time of purchase is used to calculate the gain before deducting the principal residence exemption. If a home has been owned since before 1972, only the increase in value since December 31, 1971 is used to calculate the gain before deducting the principal residence exemption.
Canada Revenue Agency (CRA) usually considers that if there is more than 1/2 hectare (1.25 acres) of property, only 1/2 hectare of the land can be considered part of the principal residence, and there would be a capital gain on the excess when the property is sold, even if the rest is the principal residence. However, they also consider whether the property is subdividable. Thus, if the property is 2 hectares, and is not subdividable, they may consider the whole amount of the land to be part of the principal residence.
If your home was not your principal
residence for the whole time that you owned it, Form
T2091(IND) Designation of a property as a Principal Residence by an
Individual (Other Than a Personal Trust) still must be filed, as
it was previously. CRA requires
this form to be filed with the tax return only if a capital gain is to
be reported, as is indicated on the form. Folio S1-F3-C2
paragraph 2.15 indicates that the form must be filed if:
Principal Residence Exemption Formula
(# of years home is principal residence +
1) x capital gain
The extra year in the top of the equation (the "one-plus rule") means that when a person moves, both the old home and the new home will be treated as a principal residence in the year of the move, even though only one of them can actually be designated as such for that year. For dispositions occurring after October 3, 2016, the "one-plus" factor applies only where the taxpayer is resident in Canada during the year in which they acquire the property.
Example of principal residence exemption:
The exemption amount is (14 + 1)/20 x 100,000 = $75,000, leaving a capital gain of $25,000, and a taxable capital gain (50%) of $12,500.
If you have both a home and a cottage, and sell one of them at a profit, you must make a decision as to whether to designate the sold property as your principal residence for some or all of the years it was owned. If you sell a cottage that you have owned for 10 years, you could designate the cottage as your principal residence for the entire 10 years in order to eliminate capital gains tax, as long as you have not designated any other property as your principal residence during that time.
This would mean that when you sell your home you will likely be paying capital gains tax, as you cannot also designate the home as your principal residence for those 10 years. If you have a significant gain so far on your home but a small gain on the sale of the cottage, it might be best to save the exemption for the sale of your home.
If you had sold a previous home at a gain say 4 years prior to selling the cottage, and did not declare the sale for capital gains purposes, then you can only claim the cottage as your principal residence for a maximum of 4 years. This is because you were deemed to have claimed the principal residence exemption when you sold the previous home.
Change in Use of Home
See also our article regarding a change in use of your home from principal residence to income producing, or from income producing to principal residence. How you do things may affect whether or not you have to report a capital gain.
Canada Revenue Agency ResourcesReporting the sale of your principal residence for individuals (other than trusts) - more information on the 2016 reporting change
Revised: October 27, 2016
Copyright © 2002 - 2016 Boat Harbour Investments Ltd. All Rights Reserved See Reproduction of information from TaxTips.ca