Tax relief on the home front
Whether you live in a region of galloping growth or more modest increases, rising real estate value can be a double-edged sword for an owner. Obviously it is comforting as a store of wealth, but can carry with it a stiff tax bill in the form of a taxable capital gain on disposition.
However, if that property is your home, the principal residence exemption (PRE) offers some of the most generous tax relief we have – in simple terms, eliminating the tax on that capital gain. Indeed, apart from the comfort, stability and control on a personal level, for many the PRE is one of the most appealing aspects of home ownership.
Principles of being “principal”
To qualify for the PRE, a property must be “ordinarily inhabited” in the year by the taxpayer, his or her current or former spouse or common-law partner (CLP), or a child. It is a question of fact whether a property is ordinarily inhabited, and in this respect there is no minimum period of time required.
The property in question (generally including land up to one-half hectare) may be in the form of:
- a house;
- a cottage;
- a condominium, apartment unit or part of a duplex;
- a share in a co-operative housing corporation;
- a life lease arrangement or similar disposable leasehold interest; or
- a trailer, mobile home, or houseboat.
(Consult a lawyer in all cases, but especially in this last category.)
Whatever the form, the fundamental condition is that it must be owned, as opposed to a periodic rental. Usually the taxpayer must be the owner, though it may also be available to a personal trust of which a qualifying taxpayer is a beneficiary. Neither a corporation nor a partnership can claim the PRE, though a member of a partnership may be able to use the PRE to reduce or eliminate a gain allocated from a partnership.
Calculating and claiming the PRE
Only one property may be designated as a taxpayer’s principal residence for a particular taxation year. Furthermore, since 1981 only one property per family unit can be designated as a principal residence; this precludes the previous ability to multiply the PRE, for example by having one spouse/CLP on title to the house, and the other on the cottage.
Pursuant to Income Tax Regulation 2301, the designation is made using Form T2091, to be filed with the taxpayer’s income tax return for the year in which the property is disposed. This includes a deemed disposition such as when there is a change in title. It also applies if there is a change in use, such as converting a property to rental or business purposes.
The taxpayer is allowed to elect the number of years to apply the PRE. That said, it is not a matter of choosing specific calendar years, but rather a proportional decision using the following formula:
Capital gain TIMES [ 1+ elected-number-of-PRE-years DIVIDED BY number-of-years-owned ]
The purpose of the “1 +” in the numerator is to accommodate for the common situation when there is a sale and purchase of property in the same year. This assures continuity such that the second property does not lose a year of claim, but does not confer any extra benefit as the PRE can only reduce the tax on a calculated gain to zero.
Provisos and pitfalls
Bear in mind that this article is intended as an overview. A lawyer should always be consulted when contemplating acquisition, disposition or change of use of real property. Here are a few more issues that could come up in those consultations:
Legal and beneficial ownership
The tax results usually follow from beneficial ownership, which may not be the same as the legally recorded title. Even so, the taxpayer has the onus to prove entitlement to any tax benefit, so where legal and beneficial ownership diverge there should be a clear record. This distinction only exists in common law provinces, whereas ownership is a unitary concept under Quebec civil law.
Renting a property
Despite the “ordinarily inhabited” requirement, there is a concession allowing for conversion to rental use for no more than four years. This may extend beyond four years if employment relocation (taxpayer or spouse/CLP) is the reason for the property being rented.
Property outside Canada
Interestingly, the property need not be located in Canada, though the taxpayer would have to be a Canadian resident to make use of the PRE.
Non-resident owners
A non-resident holding a Canadian property could technically meet the qualifying criteria (for example if a resident child was the ordinary inhabitant), but would typically be prevented from using the PRE to eliminate a gain on disposition.
Former spouses
In addition to division of assets, a written separation agreement should address ongoing property dealings. If the PRE is claimed by one party on a post-relationship disposition, the other party’s PRE entitlement will be limited or eliminated on his/her property if the two properties had been concurrently owned during the relationship.
Elections for a deceased person
An executor may use Form T1255 to make the designation for a deceased. In addition to the impact this could have on a surviving or former spouse as outlined above, the executor’s designation could affect estate distribution if properties devolve to different beneficiaries.