Selling houses can be a great source of income, and like all income it is subject to tax laws. It can be fairly simple when you own a single house and sell that in order to move to another, but that isn’t always the case. Many people own multiple houses, whether for income generation or to serve as seasonal holiday retreats. In these cases, selling a home can raise a number of questions about how you want to approach it from a tax perspective.
What is a Principal Residence?
The conventional wisdom is that a principal residence is simply a term for where you live, but it’s not that simple. While you can only have one principal residence for tax purposes, if you do own multiple homes you do have some latitude when it comes to which one you count as that primary residence provided it meets the necessary criteria. The basic rules are that you have to own the home, reside in it for at least part of the year, and can only claim it for years for which that holds true.
How Does it Work?
Property sales are generally counted as capital gains when it comes to taxation, however the Principal Residence Exemption gives you the ability to legally reduce the amount of tax you have to pay on certain transactions provided you meet the necessary criteria. Note that this is not a one-time exemption, you can claim it a second time in later years if you met the required criteria for both sales.
The basic formula is one plus the number of years you are claiming divided by the total number of years you have owned the property and then multiplied by the amount of the capital gains realised from the sale. What this means is that you benefit the most if you claim the same property as your principal residence for the entirety of your ownership. You can split things up if you have two properties that can both be treated as a principal residence and your ownership overlaps, but you gain the largest benefit by claiming the exemption for the entire time you own a property.
Basically this is a way to ensure you can’t claim the exemption for a particular property for years when you didn’t treat it as your primary residence.
Principal Residence Exemption and Your Spouse
While normally you and your spouse are treated as a unit for purposes of the Principal Residence Exemption in that you can only claim one property between the two of you in most cases, there is an exception. Specifically, each spouse can designate a separate property as principal residence for years before 1982. While it’s still legal, most taxpayers are not able to take advantage of this particular loophole in the law.
Other Criteria
While the basic rules are simple, there are other factors you may also need to take into account when determining PRE eligibility for any property you may own, ranging from the land it sits on to the use to which you put it.
What About the Land?
While the PRE can easily be applied to a single-family residential property of any size, there are limits to the amount of land that qualifies for the exemption. As a general rule, you’re allowed to claim 0.5 hectares along with the residence that sits on it. This means that if you’re selling a family farm, you can only claim the land immediately around the residence. It is possible to apply for an exception to include a larger piece of property but the CRA tends to scrutinize such requests very seriously and rarely applies such exceptions. This is just one of the areas in which an accountant or tax professional can assist you.
How About Income Generating Properties?
The whole purpose of the PRE is to give you a tax break on your primary residence, not on rental properties. This means it does not apply to properties where you live in one unit and rent out the others. It also doesn’t apply to properties bought for flipping purposes even if you live in them for a short period during or after the flip as they are considered inventory.
One case where you can claim an income generating property for the PRE is if you use the property as an Airbnb, or occasionally rent it out in the summer. The key here is that you have to be primarily using the property as a personal residence.
Another situation where you may be able to generate income from your principal residence and still retain eligibility for the PRE is if you are required to move due your or your spouse’s place of employment relocating. You cannot be related to the employer and you can maintain the designation for a maximum of four years. This does require that you write a letter to the CRA, there is no form. The rules here can be quite complex, so always check with a professional.
What About Reporting?
Over the last several years, the CRA has taken an ever-tougher stance on reporting requirements and the PRE is no exception. Under current rules, if you do not report a sale you can be liable for a late filing fee of $100 per month up to a maximum of $8,000. More to the point, this can also cause you to lose the exemption; in which case you would be liable for the full amount of capital gains tax in addition to any penalties. Some people labor under the impression that reporting is not necessary if your principal residence is your only property. That is not the case. This is just one reason why it’s so important to listen to the advice of your accountant and tax professionals.
Conclusion
With property prices rising all the time, getting the most out of your Principal Residence Exemption is becoming ever more important as the years go on. As with so many other tax decisions it is really important to get the details right so you should always check with your accountant before making a decision.