The sale of capital property normally triggers capital gains or losses; however, the capital gains arising on the “disposition” of a principal residence can be received tax-free. This is called the principal residence exemption.
Your principal residence can be any of the following types of housing:
apartment in an apartment building
apartment in a duplex
trailer, mobile home, or houseboat.
Generally, the exemption applies for each year that the property is designated as your principal residence. Note that between a taxpayer and their spouse, only one property each year may be designated as the principal residence.
Change in Use (Rental Properties)
The rules are further complicated if there is more than one property owned by the taxpayer or if there is any change in use of the residence, either from rental property to principal residence, or vice versa.
To consider which property should be designated the principal residence, the appreciation on both properties should be evaluated and generally, the exemption would be applied to the property which appreciated the most.
If there is a change in use of the residence, there is a "deemed disposition" of the property. This is where the tax laws consider that the property was disposed of and immediately repurchased at the fair market value. This may result in recognition of capital gains even though no money actually changed hands. The tax rules do allow a deferral of these capital gains; however, certain elections (ie. choices) must be filed to the Canada Revenue Agency ("CRA") in a timely manner.
Changes in 2016
Starting in the 2016 taxation year, the CRA now requires the sale of any principal residence to be reported on the T1 personal income tax return on Schedule 3, along with information such as the date of acquisition, the proceeds of disposition, and a description of the property, in order to claim the principal residence exemption. Note that if you forget to complete the form to designate your principal residence in the year of the sale, you may be subject to penalties.
The designation of a principal residence must be carefully considered when selling capital property or converting property to/from rental from/to principal residence as all principal residence dispositions must now be reported on the taxpayer's income tax return.
Whenever there is a change in use of property, an accountant or tax professional should be consulted to ensure that the appropriate elections are filed if required. Omitting an election may be more costly in the end.
Get in Touch with Omni today to find out how we can help you calculate and gains and losses and to designation your principal residence exemption!