CPA expertise can help clients maximize this exemption and minimize taxes when it is time to sell property.
When filing personal income tax returns, how to report a property sale can be confusing and expensive, dependent on value appreciation and the capital gains tax owed. Luckily, under Canada’s Income Tax Act (ITA), the sale of a residence can be exempted from this tax under the Principal Residence Exemption (PRE).
CPAs will remember that in 2016 the CRA required the sale of principal residence to be reported on the seller’s income tax in order to qualify for the PRE and to tighten up eligibility requirements.
With this in mind, there are several things Canadian property owners need to consider when filing for PRE, particularly if they own multiple properties. Here are four questions clients may ask you and how CPAs can adequately respond.
1. How long do I need to live in a residence to claim it as a principal residence and qualify for PRE?
The CRA does not specify an exact duration of time an individual or their family members, including a spouse, common-law partner or children, must reside in a dwelling for it to qualify as a principal residence for a given year. The tax rules refer to the residence being “ordinarily inhabited” within the calendar year, which is a relatively low bar. A more significant issue is whether a property held for a short period will produce an income gain or a capital gain when sold.
Clients should beware that the CRA will analyze evidence, such as length of time in the dwelling, sources of income and real estate buying patterns, to establish if the dwelling is indeed a principal residence or perhaps part of a business venture, such as real estate flipping.
“If the CRA challenges your claim of exemption, they’re going to look at all the facts in the scenario,” says CPA Michael Espinoza, senior manager, national tax office, Grant Thornton LLP. “[Such as] what was your intention of moving in and did something happen that forced you to sell [the property]?”
2. Can other properties, such as a cottage, be designated a principal residence and eligible for PRE?
Most properties (home or cottage, for example) can be designated a principal residence – even those seasonal residences located outside of Canada, such as in the U.S. or Caribbean – as long as the owner or their family ordinarily inhabit it during each calendar year being claimed.
Clients should be aware that only one property per year, per family (spouse or common-law partner and children under 18), can be designated a principal residence. Although it is becoming rare now, each spouse can designate a different property as a principal residence for years before 1982. Once sold, a property that isn’t deemed a principal residence will be subject to capital gains tax for the years it was not designated. A gain may also arise if the residence is designated for some, but not all, of the years of ownership.
There is also a restriction on land size that qualifies for the PRE. Property that exceeds one-half hectare (roughly 1.2 acres) will generally not qualify for the exemption. For example, if the property is a farm, only one-half of a hectare of land plus the home would qualify for the exemption, while the remaining acreage would be subject to capital gains tax based on value appreciation. If the excess land is required for the use and enjoyment of the property, then the land that qualifies can be larger. However, CRA is very restrictive when applying this rule.
When selling one of multiple properties owned, an owner can designate it as a principal residence for all or part of the years of ownership to take best advantage of the exemption and minimize the amount of capital gains tax paid.
“Generally speaking, it makes sense to designate the property that has the highest average gain per year of ownership,” says Bruce Ball, FCPA, vice-president of taxation at CPA Canada. “However, there are a number of factors to consider and getting advice from a CPA may help reduce your tax.”
Clients should speak to a tax professional to assess how best to calculate this, experts say.
3. Can a property that generates income be deemed a principal residence and eligible for PRE?
The mandatory income tax reporting of a principal residence sale was introduced by the CRA to limit when the exemption could be applied. Overall, it increased monitoring over foreign property ownership, “quick flips” or short holdings (on properties that may not qualify for principal residence status), properties that were not “ordinarily inhabited” every year by the owner, a well as serial builders who build and occupy a property before selling it.
Therefore, property that is used mainly to generate income or that is considered inventory does not qualify for PRE. This includes property that is solely rented out on a long- or short-term basis, or one where the owner occupies one unit and rents out the others.
Exceptions include renting out property for the short term, such as a cottage for a couple of weeks in the summer or a house as an Airbnb while on vacation, which an owner occupies otherwise; and if a family member (spouse or common-law partner or child) rents out the property.
“If, for the most part, you are using [the property] for your own purposes … then it will qualify for a principal residence, even if you use Airbnb,” says Espinoza. “Which means you could have people coming in frequently, as long as you are living there [regularly, in some capacity].”
4. What penalties are incurred when the sale of a principal residence is not reported to the CRA?
If an owner fails to report the selling of a principal residence, they could be subject to a late-filing penalty of $100 per month, up to a maximum of $8,000, according to the CRA. In addition, if an owner doesn’t report the sale, the exemption may be denied and therefore the owner would be taxed on the capital gains.
“Although the new reporting requirements have been in place for several years now, many individuals may still believe that they do not have to report the sale of the principal residence when they only own one property,” Ball says. “Failing to report the sale can result in significant costs.”
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.