The benefit of the principal residence exemption is obvious. As long as the sale qualifies, you will not pay tax on the profit you made from selling your principal residence.
When you normally sell a property, you are subject to tax on the gain from the sale. The gain is typically the difference between the price you paid, any improvements made, and the sale price. If the principal residence exemption applies to the sale, it would eliminate the capital gain and eliminate the need to report the sale on a tax return.
Taxpayers should keep in mind that the exemption may only remove a portion of the capital gain. If this is the case then the sale must be reported as there will be some taxes owing.
What is a Principal Residence?
A principal residence is a property where a taxpayer, his or her spouse or common-law partner, or any children live in at some point during the year. You do not have to live the majority of the year in the property to designate it as your principal residence.
An interesting tidbit is that a principal residence does not have to be located in Canada.
You and your spouse are only allowed to designate one property as your principal residence in any given tax year. If the property was owned prior to 1982, you and your spouse can designate separate properties as principal residences.
Half Hectare Rule
If your principal residence is more than ½ hectare (1.25 acres) of property, then the Canada Revenue Agency (CRA) has stated it will only allow the ½ hectare to be considered part of the principal residence. What this means is if your principal residence resides on property larger than ½ hectare, there would be a capital gain to report on the excess property once it has been sold.
There are situations where the CRA will allow more than a ½ hectare for a principal residence. Typically this is where the property cannot be subdivided. You should seek legal assistance if this situation applies to you.
Length of Ownership
If you have owned a property for more years then it has been your principal residence, you will have to report the sale on your tax return. Furthermore, there will be a calculation to complete to see how much principal residence exemption you are entitled to. What this means is that even though it has not always been your principal residence, you can calculate an amount that would not be included as a capital gain because the property has been your principal residence for a certain period of time.
The principal residence exemption formula is as follows:
(# of years home is principal residence + 1) x capital gain
# of years home is owned
As you can see above the formula provides an extra year. This can be extremely beneficial when a taxpayer owns more than one property.
Example of principal residence exemption:
- Taxpayer has owned their home for 20 years;
- It has been their principal residence for 14 years; and
- The capital gain before the exemption is $100,000.
The exemption amount is (14+1)/20 x $100,000 = $75,000. So $75,000 is tax-free, and the remaining $25,000 is a capital gain. The taxable capital gain is $12,500.
When you own a cottage and a home for the same number of years, it can be very complicated knowing the best tax strategy for designating one, or the other as your principal residence in the year of sale.
This involves calculating the difference in tax amounts, and the values of the properties from the time of purchase to the time of sale.
Change in Use
Please see our article regarding change in use here.
If you have any questions regarding the Principal Residence Exemption, or are have been contacted by the Canada Revenue Agency regarding your usage of the exemption, give us a call today to see how we can help!
Income Tax Act
Voykin v. The Queen, 2004 TCC 658 – Adventure in the Nature of Trade
Freer v. The Queen, 2003 TCC 20 – Capital vs. Business Income
Giusti v. The Queen, 2011 TCC 62 – Condo Flipping
Detailed case law analysis may be found here.
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.