In Canada, the capital gains from the sale of a qualifying primary residence is exempt from taxes. In the past, the individual was not required to report the sale on their personal income tax return provided the entire gain was eligible for exemption. However, on the 3rd of October, 2016 the federal government announced an administrative change to the reporting requirements to prevent misuse of this exemption. The following is an overview of the current and updated Canada Revenue Agency’s (CRA) principal residence exemption tax regulations for Canadians considering a sale of their residence.
Overview of CRA’s Principal Residence Exemption Regulation
In Canada, if a house is occupied by the owner, or by his/her spouse, domestic partner or children, then the house qualifies as a ‘principal residence’. If a portion of the home is used for business or rental, then only the portion used personally qualifies as a principal residence. Any capital gain from the sale of this principal residence is exempt from taxes. This is known as the “Principal Residence Exemption”. This rule is applied regardless of whether the house was occupied for a long or short duration, and could be claimed by residents as well as non-residents only if they were Canadian residents at the time they lived in the home. Furthermore, if the Canadian individual had two or more properties, such as a cottage, he/she must choose which property to designate as the principal residence in a given year. Even in the case of two or multiple properties, the person can claim the ‘principal residence exemption’. However, only up to certain limit which is based on this formula:
(1 + number of years designated as principal residence x gain) = Exemption Amount Total number of years of ownership
In addition, if the taxpayer was married or living common-law, the couple must designate the same residence as their principal residence for the year. It is not necessary that the property should be located in Canada, however, the taxpayer, their spouse or child(ren) must be a Canadian resident for any year he/she is designating the property as his/her principal residence.
Principal Residence Exemption Regulation prior to 2016
As mentioned earlier, individual’s who sold a property that was designated as his/her primary residence for the entire ownership period, would be exempt from capital gains taxes and no reporting requirement would be required. If the property was not the taxpayers’ principal residence for every year he/she owned it (e.g., a different property, such as a cottage, was designated as a principal residence for one of the years during the same period of ownership), then he/she would need to file Form T2091 (IND), Designation of a property as a principal residence along with T1, Income Tax and Benefit Return to claim principal residence exemption for that residence (if it qualified). Non-resident Canadians could also claim this deduction, if certain conditions were met.
Principal Residence Exemption Regulation from 2016 Onward
Starting with the 2016 tax year, individuals who sell their principal residence will have to report the sale on Schedule 3, Capital Gains of the T1 Income Tax and Benefit Return. Reporting will be required for sales that occur on or after January 1, 2016. If the entire property was the taxpayers’ principal residence for every year it was owned, the principal residence designation will be made on the Schedule 3. In this case, the year of acquisition, proceeds of disposition and the description of the property are the information that will have to be reported. Note that, Form T2091 will still be required for the designation in the case the property was not a principal residence for all of the years it was owned. For the sale of a principal residence in 2016 or later tax years, CRA will only allow the principal residence exemption if the sale and designation of principal residence is reported on the income tax return. If the designation is not made in the year of the sale, it is possible to amend the return for that year. Under proposed changes, the CRA will be able to accept a late designation in certain circumstances, but a penalty may apply. The penalty is the lesser of the following amounts:
- $8,000; or
- $100 for each complete month from the original due date to the date a request was made in a form satisfactory to the CRA.
In addition, the CRA can reassess a taxpayer outside of the normal 3 year reassessment period, if the taxpayer does not report a disposition. Along with the mandatory reporting requirement, the CRA has discontinued the availability of the plus-one formula if they were non-residents of Canada in the year they acquired the property. Those effected selling property after October 3, 2016 will now have to use the following formula to determine the exempted amount:
(number of years designated x gain) = Exemption Amount number of years owned
However, if the non-resident individual has a Canadian-resident spouse or child that is reporting a portion of the gain, he/she could still access the plus-one formula provided the exemptions is claimed by the resident spouse/child. The CRA’s previous administrative practice did not apply to trusts, however, the new rules also extend to cover trusts. Under the new rules, trusts, such as: qualified disability trusts, trusts for minor children of a deceased parent or other spousal/common-law trusts may qualify for principal residence exemption upon sale of a qualifying property owned by the Trust, provided the trust’s beneficiary is a resident of Canada and must occupy the home as a principal residence for the immediate period before disposal. If a principal residence is held in a trust, you should consult a tax professional to assist with the reporting requirements. The new rules will also apply to a deemed disposition resulting from the death of a taxpayer or change in use of the property. With the stringent regulations regarding the principal residence exemption it is likely that the CRA will also enhance the audit process related to Principal Residence Exemption claims to prevent individuals from double dipping on the exemption or making a false claim.
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