The family home is one of the very few potentially tax-free investments available to Canadians. This is achieved through the “principal residence exemption” (PRE), a valuable provision in the Canadian income tax system that ensures that the sale of the family home, plus a reasonable amount of the land on which it stands, does not generally create a tax liability.
While the concept of the principal residence exemption is simple, there are many rules in the Income Tax Act designed to ensure that the basic concept is not abused.
There can only be one principal residence per family unit at any given time, at least since 1981. A family is generally defined as the spouses (or common-law partners) plus their minor children. Each spouse can claim his or her own PRE in respect of separate properties, for periods of ownership prior to 1982.
Almost any type of housing unit can qualify as a principal residence. The general definition is any property that is ordinarily inhabited by the taxpayer, such as a house, cottage, condominium unit, trailer, house boat or mobile home. The period of occupancy can be quite short, such as a summer vacation home that the family visits for a few weeks each summer.
The PRE shelters a capital gain from taxation but only on one property in any year. As such, it often makes sense to claim the exemption against the “home” with the biggest gain. Contrary to popular belief, the disposition of the family home is a reportable transaction and could
generate a capital gain. Fifty percent of the capital gain is reportable as a taxable capital gain on the individual’s tax return. However, claiming the PRE can offset part or all of the capital gain, to reduce or
eliminate any income tax on the sale. As taxpayers are sometimes under the impression that the gain on the sale of their home is simply a non-taxable item,many do not file the appropriate forms with their tax
The appropriate form should be filed with the tax return in the year the family home is sold. The Canada Revenue Agency (CRA) takes the administrative position that if the forms are not filed, the taxpayer is considered to have designated the property as the principal residence and to have elected to claim the principal residence exemption for that property for the years it was owned. This may create issues when the family has more than one home that potentially qualifies as the principal residence during any taxation year. A presumed election on the sale of one home precludes the ability to elect, for those same years, on the other home, which could create a larger tax liability if that second home had a larger capital gain accrued over the years in question.
Any time a family owns more than one property that could be classified as a principal residence, such as a home and cottage, the tax implications should be examined when the first property is disposed of.
The capital gain that is reportable on the sale of a principal residence is determined by the following formula: A – ( A x B/C ) – D
– A is the amount of capital gain otherwise determined
– B is the number of years the property is declared as the principal residence, plus 1
– C is the number of years of ownership (after 1971)
– D is a factor to pick up any 1994 capital gains exemption election claimed in respect of the property
The CRA sets out its administrative position with respect to principal residences in an Interpretation Bulletin IT120R6 – Principal Residence.
It addresses homes outside of Canada that may qualify as the taxpayer’s principal residence. However, the foreign tax exposure and the foreign tax credits would have to be carefully reviewed in order to determine whether the principal residence exemption would be of value to the taxpayer.
Lastly, it should be noted that any losses realized on the sale of the family home are never tax-deductible because it is considered personal-use property. The tax-free accumulation of value within the family home is an important financial component of many wealth accumulation and wealth transfer plans. However, it is important to keep the detailed rules in mind in order to ensure that tax is minimized
wherever possible. And considering the long time frame involved, the importance of keeping records of all capital costs cannot be overemphasized.