Canada: Home Sweet Home

Selling your home? Don't get thrown by the principal residence exemption
Last Updated: October 7 2014
Article by Samantha Prasad

Selling your home? Don't get thrown by the principal residence exemption.

Selling your home? If so, you are likely caught up in the usual headaches that come with such a transaction: getting the right selling price, boxing up your possessions and finding a new home to live in. And as a result, you may not be focused on the tax implications that are as much a part of moving as cardboard boxes and packing tape.

We often reassure ourselves that we're covered by the principal residence exemption, which prevents us from having to pay capital gains tax on our homes.

But, the principal residence exemption is not as simple as we like to think. Here`s a summary of some of the more important rules to keep in mind if you want to take advantage of the exemption:

  • The home must be ordinarily occupied for personal use by you, your spouse or former spouse, or a child at some time during the year.
  • To claim the principal residence exemption on a large lot (over half a hectare – about 1 acre), you must be in a position to establish that the land over half a hectare is necessary for the "use and enjoyment" of your home.
  • Restrictions will also apply if part or all of your home is rented out or not used by a family member, or if you have not been resident in Canada throughout the period of ownership.
  • As a general rule, a family can claim the principal residence exemption on only one home at a time. So a second home (such as a cottage) is more of a problem: to stop you from trying to claim a separate exemption for another home by putting it in the name of a child, children are restricted from claiming the exemption unless they have reached eighteen in the year or are married.

How it works

Most people think of the principal residence exemption as a black and white matter: either you qualify to sell tax free, or you don't. Actually, this is not the case.

When you sell your home, you must calculate the gain on your residence just like any other capital gain. Then the principal residence exemption itself reduces your gain.

Moreover, eligibility for the exemption is on a year-by-year basis, which might come as a surprise to you. The more years you qualify relative to your total period of ownership, the more your gain gets reduced. To be more precise, the following is the basic formula that normally applies:

As you can see, to get the tax reduction, you must designate the home as principal residence on a year-by-year basis. (If your gain is completely covered by the principal residence exemption, it is not necessary to file the designation form with your tax return.)

The principal residence exemption has also been the focus of various caselaw.

In a 2013 case (Sangha), the principal residence exemption was denied where the house was built with intent to sell it at a profit. The taxpayers lived in the house for a few weeks in an attempt to establish it as a principal residence; however, the house was never furnished and was for sale the entire time.

Another case decided by the Federal Court of Appeal (Cassidy) focused on whether a taxpayer was entitled to the principal residence exemption for a property that was more than half a hectare.

As noted above, in order for any excess land to qualify, it must be necessary for the use and enjoyment of the home. In this case, the home sat on 2.43 hectares of land and was owned by the taxpayer from 1994 to its sale in November 2003.

The taxpayer argued that since he was legally unable to subdivide the land (up until May 2003), the entire 2.43 hectares was necessary for his use and enjoyment since he could not put a home on a smaller piece of land.

In the initial judgment, the Tax Court of Canada agreed with the CRA in denying the principal residence exemption on the basis that the half hectare rule applied only on the date of sale. And since the sale was in November 2003, the restriction on the subdivision was no longer in place.

However, the Federal Court of Appeal rejected that argument and sided with the taxpayer in holding that the principal residence exemption determination is made each year and not just at the time of sale. Therefore the principal residence exemption applied to the entire 2.43 hectares.

Another trap that you may find yourself stumbling into relates to the situation where part or all of the residence becomes non-personal use.

Specifically, where part of the property is rented out, the value of the residence itself must be pro-rated as between personal and non-personal use, and only the personal portion will qualify for the personal residence exemption. But on what basis? The appreciation on a residence is composed of land and building components. In many areas of Canada, most of a gain is attributable to land values rather than building values, especially since buildings tend to depreciate as they get older.

The standard advice is to pro-rate the land gain in the same ratio as building use. But in the right circumstances, you might be able to make an argument that a greater proportion of land is eligible for the personal residence exemption.

Change of use

Easy enough right? Well, here is where the rules get a bit trickier. If the property itself changes from being a home for you or your family to being a rental property (i.e. from personal use to income-producing use), then you will be deemed to have disposed of the property (both land and building) at fair market value and reacquired it immediately thereafter at the same amount.

Any gain otherwise determined on this deemed disposition may be eliminated or reduced by the principal residence exemption.

You are, however, entitled to elect that no change in use is considered to have taken place if you make an election to treat the property as a principal residence. This election can be made by means of a letter to that effect signed by you and filed with the income tax return for the year in which the change in use occurred.

Be aware, however, that if capital cost allowance (CCA) is claimed on the home, the election is considered to be rescinded on the first day of the year in which that claim is made.

If you make this election, the property can qualify as your principal residence for up to four taxation years during which the election remains in force, even if the residence is not ordinarily inhabited during those years by you, your spouse or a child.

However, you must remain a Canadian resident during these years for the full benefit of the principal residence exemption to apply.

This election is advantageous if you move back into the residence since any change from income-producing back to personal use will also result in a second deemed disposition.

If you had made the election that no change in use was to apply to the residence when it first changed from personal use to income-producing use (so that it remained a principal residence), when you move back into the residence at a later date there will be no change of use since the property will have always been deemed to be personal use.

And you can designate four of those years you were away as part of the principal residence exemption to shelter a portion of the gain.

There are ways to get around this four year limitation in certain situations. If you are renting your residence due to the fact that you, or your spouse, are required to move by your employer, none of the years you are away from the residence and renting it will be included in the 4 year limitation period ordinarily imposed by the election (i.e., it can be extended indefinitely). This applies only if the following conditions are met:

(1) you do not ordinarily inhabit the home during the period of the election because your (or your spouse's) employment has been relocated;

(2) the employer is not related to you or your spouse;

(3) the home is at least 40 kilometers farther from the new place of employment than your old place of employment; and

(4) either:

(a) you resume living in the home during the term of your (or your spouse's) employment with that employer;

(b) if your (or your spouse's) employment with that employer is terminated and you resume living in the home before the end of the next taxation year; or

(c) if you (or your spouse) pass away during the term of your (or your spouse's) employment with that employer.

Conversely, if a property which you have being using to earn income becomes your principal residence, there will be a deemed disposition based on the change of use rules.

Again, however, you can defer the recognition of any gain or loss on the deemed disposition arising from the change in use by making the necessary election which operates in the same way as the one discussed above.

Note that this election does not defer the recapture of CCA on the change in use and in fact the election will not be allowed if any CCA has been claimed on the property after 1984 and before the property becomes the principal residence of the taxpayer.

And, to make the story complete, there will also be a deemed disposition if you partially convert your principal residence to an income-producing use, and the partial change is substantial and of a more permanent nature, i.e., where there is a structural change.

The CRA cites certain examples of this occurrence as including the conversion of the front half of a house into a store, a portion of a house into a self-contained apartment (i.e. a duplex, or triplex) or alterations to a house to accommodate separate business premises.

And you would think that if there is going to be a deemed disposition, that the CRA would also give you a break and allow you to make an election as in the case where there's a total change in use. Right? Wrong.

There is no election avail- able where there is a partial change in use. Instead, the CRA has administratively stated that they will not apply the deemed disposition rule (and hence, the property will retain its nature as a principal residence) if all of the following conditions are met:

  • the income-producing use is ancillary to the main use of the property as a residence;
  • there is no structural change to the property; and
  • no CCA is claimed on the property.

Examples of when these conditions can be met include where you carry on a business of caring for children in your home, rent one or more rooms in the home, or you have an office or other work space in the home which is used in connection with your business or employment.

Although you may claim expenses pertaining to that portion of the property used for income-producing purposes, the CRA will jump in to apply the deemed disposition rule if you claim CCA on that portion of the residence.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Samantha Prasad
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions