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Detailing the ‘new’ principal residence tax exemption

We will all have to be far more diligent in reporting the sale of our private homes because of much closer scrutiny by the CRA, says William Cooper of Boughton Law
tax

 

The principal residence exemption (PRE) is one of the biggest tax loopholes in the history of the Canadian Income Tax Act. It has likely resulted in billions of dollars in lost tax revenues. Not because of the PRE itself, but because ordinary taxpayers played fast and loose with the reporting of taxable gains on the sale of their residences.

Indeed, no reporting of a disposition of a principal residence (PR) was required by the Canada Revenue Agency (CRA) until the changes were announced in October 2016. While this change was justified on the grounds of abuse of the PRE by foreigners, the real problem was with house flippers, estates, and rental properties owned by everyday Canadians that did not fully qualify for the PRE and were never reported.

Starting with dispositions of residences in 2016, a new form, T2091, must be completed that specifically calculates the gain on a PR and determines the amount of available PRE. It should be noted that the PRE is no longer available unless the PR disposition is reported on a taxpayer’s return, although late filings with penalties may be permitted.

The new reporting formula allows taxpayers to take advantage of the “one-plus rule.” When determining the formula percentage of the exempt taxable gain, if homeowners have lived in a house for the same number of years they owned it, they should claim PR status for one fewer year than the years of ownership. The PRE exemption is an annual qualification test and the portion of the gain subject to the PRE is determined at the time of disposition as a percentage arrived at by dividing the number of years in which owners “ordinarily inhabited” the residence and designated it as their PR plus one, by the number of years they owned it. This allows for the overlap of ownership when one changes homes during a year. You must be a resident of Canada to claim the exemption in any one year.

Of perhaps even greater significance is a suspension of the normal limitation period for the CRA to reassess virtually any taxpayer who fails to report a real estate sale or other disposition where the real estate is held as capital property at the time of disposition. 

While the main focus of the legislation was purportedly to limit the ability of foreigners to claim the PRE and trusts to designate a PRE, the suspension of the limitation period applies to all taxpayers with sales of real estate that is capital property. It should be noted that the definition of “principal residence” in the Tax Act deems it to include the land upon which the housing unit stands and any portion of the adjoining land that can reasonably be regarded as contributing to the use and enjoyment of the housing unit as a residence. Where the total area of the land upon which a housing unit is situated exceeds one half-hectare, the excess land is deemed not to have contributed to the use and enjoyment of the housing unit as a residence and thus will not qualify as part of a principal residence, except to the extent that the taxpayer establishes that it was “necessary for such use and enjoyment.” The excess land must clearly be necessary for the housing unit to properly fulfil its function as a residence and not simply be desirable.

So what does all this mean for taxpaying Canadians? 

Well, it is clear that we will all have to be far more diligent in reporting the sale of our PRs. The PRE is not at all straightforward and requires a year-by-year analysis of eligibility. Of particular importance is the portion of the value of the PRE that can be considered to contribute to the value of the PR. Consider for example that a portion of a house may be used for office space or a rental unit. Also consider the use of the underlying property for a laneway house or the fact that the property sits on an “acreage” that was once a mandatory minimum, say five acres, that the local municipality has reduced to a city lot size. Changes in zoning status will require a year-by-year analysis of PR qualification but the new form does not provide for such complexities.

Here are a few observations:

  • One may designate a cottage, cabin or other vacation property as one’s PR but each family unit can have only one principal residence.
  • Where two spouses owned different PRs for years before 1982, a partial exemption for both is still available.
  • Where a home is used partly to earn income (rented out, or as a bed and breakfast, or to operate another business), the CRA’s view is that the property “retains its nature as a principal residence” as long as the income-producing use is ancillary to the main use of the property as a residence, there is no structural change, and no Capital Cost Allowance is claimed on the property.
  • A PR can be outside Canada.
  • Where an individual lives downstairs and rents out the upstairs, only the downstairs is the PR.
  • All of the land under a laneway house may be considered to be necessary to the use and enjoyment of the house on whose property the laneway house sits.