Complaining about taxes is almost a sport in Canada, especially when we look to our U.S. neighbours for comparisons. But there are some areas in which we actually win the tax race, and one of these is our Principal Residence Exemption provision.
Americans, for example, pay capital-gains tax on the sale of their residence for any amount exceeding $250,000. In Canada, there is no monetary limit on the size of the capital gain that can be excluded from income tax following the sale of a principal residence. Full capital-gains taxes apply to the sale of other properties, so the designation of a principal residence represents significant savings.
There is one downside: Canadians cannot claim a capital loss if money was lost on the sale. But real estate typically goes up in value, so this is rarely an issue.
So what is a principal residence? For tax purposes, it is simply the home you tell the Canada Revenue Agency is your main abode. You must occupy it at some time during the year, and you can actually choose a seasonal residence such as a cottage if that saves you some tax dollars. The occupancy requirement must be met for each year you want to make the designation.
There are some restrictions, of course. Only one property can be claimed as your principal residence, regardless of how many properties you occupied during the year, and only one can be selected per family unit. (A family unit includes your spouse or common-law partner, unless you were separated throughout the year, and children younger than 18 who are themselves not married or common-law). If you have more than one property, you select the principal residence once per year. That means you can wait until you sell a property to decide if it was your principal residence that year.
If you are lucky enough to own a large property, there is a size limit on the savings: if your land is larger than 0.5 hectares, the excess portion will usually not be covered by the exemption. If you can demonstrate that all that space is necessary for the use and enjoyment of the place as a residence or that there was an external factor—such as a minimum lot-size restriction when you made the purchase—the government may grant an exception.
The rules become more complicated if you convert a property from personal-use to an income-producing use. If, for example, you moved out of a house and began renting it, the tax authorities will consider it sold for its fair market value at that time. But it is possible to elect for the change of use not to have officially occurred and defer the disposition until you actually sell the property. This election also allows you to continue to designate the property as your principal residence for up to four years, even though you are no longer occupying it, or for six if your employer moved you.
The catch is that you must still report the rental income and you cannot claim a deduction for capital cost allowance if you want the election to continue in effect. The election must be made with your tax return for the year in which the change of use occurs.
If, on the other hand, you convert a rental property to your principal residence, it will be considered as sold for market value on the day you make the designation. And again, there is an option here: you can elect to defer the capital gain resulting from the deemed disposition until you actually sell the property.
The ins and outs of the principal residence rules can be confusing. But most people own only one property and actually live in it, so for them the process is simple: there is no additional tax bill on the profit made when a house is sold. See the CRA’s Principal Residence page for any forms you need. Once you own multiple properties, it is probably best to seek the help of a tax professional or use tax software.
Consider an online program like H&R Block’s Tax Software (www.hrblock.ca), which will identify your tax situation and calculate deductions or credits as you go. Or if you would rather leave it to an expert, drop by an H&R Block office. A tax professional will even review your previous returns for free.