01 Nov The Principal Residence Exemption
The following is a discovery agreement only and should not be construed as providing final information or recommendations. Nor should you consider this legal or accounting advice. Before taking any action you should have a thorough discussion with your professional advisors. We will be pleased to discuss our findings and conclusions with them.
Special acknowledgement goes to:
- Lea Koiv, Lea Koiv and Associates Inc., “Taxation of Gains on Principal Residences”
- Kay E. Gray, Grant Thornton Consulting, “Tax issues related to Multiple Dwelling Units (AKA Laneway Houses)
If the client(s) (or any of their family members) are a U.S. citizen, hold a U.S. green card, or are otherwise considered a U.S. resident for U.S income/estate tax purposes, the Canadian and/or U.S. tax implications could be substantially different from those outlined herein.
Please review the following in order to point out to us any incorrect or incomplete information, assumptions and/or data.
The Principal Residence Exemption:
For many people the most valuable financial asset they own is their home. One reason people place so much importance on their home is the tax free nature of the proceeds when they sell or, otherwise, dispose of the property, say through an inheritance to family on death.
Most property, when sold or left to heirs is subject to a calculation of the gain on the property, the amount in excess of the original purchase price plus any adjustments for capital additions or in some cases depreciation.
For a principal residence the gain can be exempted from tax through the use of a special calculation – the principal residence exemption.
What gives you the exemption?
First, it can only include a single housing unit for a couple (once there was an exemption for each person but that was changed some years ago to only one per couple) plus the land it is situated on.
The residence must be ordinarily inhabited in the year by the taxpayer, spouse or common-law partner, former spouse or common-law partner, or child.
The amount of land is usually limited to ½ a hectare but can be extended if the land is necessary for the use and enjoyment of the residence or is required by a municipal rule (eg: each residence must be built on 1 hectare of land).
You can only claim the exemption for years when you are a resident of Canada.
You designate a principal residence by year NOT by specific property, therefore, you can have different principal residences in different years while still owning multiple properties, but the designated principal residence will have to be identified in the year.
What can take away the use of the exemption?
Now, ( 2016 or later) when you sell your residence you must report the sale to CRA and make the designation on your tax return in that year.
If you “forget” to include the sale and designation on the return then penalties of the lesser of $8,000 or $100 for each month from the original date the request is made as required – so it can get expensive.
Non-residents can only obtain the exemption, as noted above, for years where they were resident in Canada and inhabited the property on a continuous basis.
Should the residence be held in a trust it may not be eligible for the exemption, except if the trust is an alter ego, joint spousal, common-law, spousal or common-law partner trust. Or if the trust is a qualified disability trust or if the trust was an intervivos or testamentary trust where the “settlor” died before the start of the year and the eligible beneficiary is a Canadian resident minor child.
If a non-qualifying trust holds a property then any years after 2016 will not be applicable to the calculation of years for the exemption.
Some individuals may have established trusts to hold property for probate avoidance or to avoid certain dependent relief legislation or to hold US property for Canadian citizens who are not US residents. A trust and estate professional should be consulted in these situations or whenever considering the use of a trust.
Another important consideration – building a Laneway house:
In the city of Vancouver, in particular and possibly other municipalities across Canada, the need for housing is impacted by a lack of space on which to build them.
In Vancouver it may be possible, in certain circumstances to take advantage of zoning rules allowing more than 1 dwelling on a single family lot.
The property could hold a primary house plus a suite or apartment contained within the primary house and a separate self-contained laneway house in the back of the property.
There are a number of reasons a homeowner may build a laneway house on their property. Perhaps they have an elderly or disabled relative they want to keep nearby or they want to provide housing to an adult child for post-secondary education or even a place for a live-in nanny or housekeeper to live.
For a person who has built a laneway house, they have complicated their life in ways they may not have contemplated.
Legally, there is only one legal title covering all the dwelling units on the property.
Therefore, from an income tax perspective, the laneway house is not a separate property and cannot be transferred, for instance, to a corporation under Section 85.
If the laneway house is being rented then there may be GST and other tax considerations to take into account.
And, for the purpose of this particular paper, the home-owner’s principal residence exemption for capital gains may be negatively altered since, as noted above, the principal residence includes only a single housing unit plus the land it is situated on provided the land is necessary to the use and enjoyment of the principal residence. Therefore, the land the laneway house is on is not necessary to the use and enjoyment of the main residence and no longer qualifies for the exemption.
There are other considerations such as a change of use related to the property. Is the laneway house for personal use or income producing use?
CRA considers personal use – renting the property to a family member or using the property as a guest house for friends and family or accommodating a nanny employed to care for the taxpayer’s children.
If a laneway house was built for personal use and then that use is changed, or it was built for an income producing purpose, then the portion of the property on which the laneway house is situated plus all land necessary for the use and enjoyment of the laneway house is subject to a change of use under the income tax and the properties must be apportioned between personal and income use.
Depending on the original purpose for use of the laneway house, the value of the land only may be subject to change of use but not the laneway house building (if the original purpose was to use it for income) but if the original purpose was personal use and eventually the use was changed then there is a more complex calculation of tax cost and value.
Since a change of use is a partial disposition of some of the land and or building value the taxpayer will have to make a principal residence designation for all the years they own the property after building the laneway house and for the entire property up to the date of the change of use.
Owners of multiple properties – choosing the residence for the exemption:
Simply put, one would probably want to use the exemption for the property with the most significant gain. For instance, if you owned a house that you bought 20 years ago (1998) for $250,000 and it is now worth $1,500,000 and you also owned a vacation property that you bought 10 years ago (2008) for $300,000 and is now worth $500,000 the logical choice is the house.
Another way to consider this is to use the increase in value per year:
House 1,500,000 – 250,000 = 1,250,000/ 20 = $62,500 per year increase
Vacation property 500,000 – 100,000 = 400,000 / 10 = $40,000 per year increase