In the past, under its administrative policy, the Canada Revenue Agency’s (CRA) did not require you to report the sale of your Principle Residence (PR) on your tax return. This policy changed in 2016, and CRA now requires everyone to report the sale on their tax return. In fact, in addition to reporting the sale and designating your principal residence on your tax return, you may have to complete Form T2091 (IND) as well. While the sale of a principal residence is still tax free, there is however, a penalty if you fail to report it sold.

Reason for the reporting requirement

The reason for the change in policy was to close current tax loopholes that directly apply to real estate earnings. In particular, the rules tighten and enforce the requirement necessary for claiming the capital gains tax exemption on a principal residence. In this regard, there are situations where sale of a residential property may not qualify as PR such as:

• “quick flips” or short holding periods where the home may not qualify as capital property, a condition of being a principal residence
• a house that was not ordinarily inhabited in each year of ownership by the vendor , another condition to qualifying as principal residence, and
• serial builders who build, then occupy, a house before selling , again, these would be considered inventory and not a capital property

The new rule will result in new audit leads, and will undoubtedly give rise to many more homeowner audits and reassessments resulting in an increase in principal residence exemption denials by the CRA. With this in mind, it is crucial to have a good understanding of the rules that apply to disposition of residential properties.

What qualifies as a principal residence?

Any residential property owned and occupied by you or family at any time in a given year could be designated as a principal residence (PR). In this regard, a PR can be a detached or townhouse, a condominium, a cottage, a mobile home, a trailer or even a live-aboard boat.

Capital gains and the principal residence exemption

Appreciation in the value of an asset is subject to Capital Gains Tax (CGT). Previously, if for all the years that you owned your home you designated it as your PR, then the appreciation in its value was not taxable and you were not required to report the gain. Under the old rules while you were required to complete form T2091 and provide it to CRA if requested, but the CRA rarely ever requested the completed form T2091.

Under the new rules, appreciation in the value of one’s home is exempt from Capital Gain Tax provided that the home is designated as PR and the CRA is accordingly notified. In deciding on the number of years to designate a property as your PR, you are limited to the years of its ownership. However, years you so designate, cannot be used again in designating another home that you own. The new rules require that designation years are reported on your tax return. The key here is that you can only designate a single year only once. For instance, if you designate 2014 to your cottage, you can’t use 2014 again when you eventually sell your city home.

If you own two eligible residential properties at the same time, it is possible to spread the capital gains (CG) between the two properties. The percentage of CG that is exempt from tax is calculated by the fraction that designated years plus one, bears to the number of years of ownership for each property. For example, if you own a home for 15 years, you would designate it as your principal residence for only 14 of those years. (Fourteen plus one equals 15 years; divided by the 15 years owned means that 100 per cent of the gain is sheltered by the principal residence exemption.) The “one plus” in the rules is to ensure that when a home is sold in a year and a new one is purchased in the same year, then it will be also fully  covered by the principal residence exemption on its eventual sale.

Let’s look at a situation where you are selling two eligible properties in the same year. In this situation, to maximize your exemption, it is important to figure out which of the two properties should be designated for which years of ownership. This is because the rules allow you assign a portion of the principal residence exemption to each or the two properties. For example, say you’re selling two properties in 2019 and you bought them both in 1999. If you choose to designate your house for 19 of those 20 years, you’ll have one year left to be used on the other property. If you’re doing this right, you can exempt all of one property and a piece of the other, but you’ll never be able to entirely exempt both. Logically, you designate as many years as needed to the property with the largest gain and use whatever is left on the other property.

With the new rules, CRA also provided a simplified method for reporting the sale of the principal residence. On Schedule 3 of your income tax return, there is a section for the sale of a principal residence. If you choose to designate the property for all the years owned, then the only information you need to provide is the address of the property, the year it was acquired and the proceeds of its sale. This is a simple way to report the sale of a principal residence for anyone who does not own another eligible property at the same time. However, for anyone who owns a second property at the same time, using this method would result in increased tax on the second property. Instead of using the simplified method, individuals who own a second eligible property should complete form T2091.

To comply with the new rules while making sure that you maximize the exemption you are entitled to, we strongly advise to consult your accountant.

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