What you need to know about the principal residence exemption
The principal residence exemption provides a generous tax break. However, there are some rules you need to be aware of.
The principal residence exemption provides Canadian taxpayers with a generous tax break, possibly one we take for granted. In other countries the gain on the sale of a residence is not always completely free of tax. In the United States, for example, only the first $250,000 is exempted. For Canadian tax purposes, there is no monetary limit on the size of the capital gain that can be excluded from your income.
However, there are restrictions on the size of the property that can be covered by the exemption. The magic number is ½ hectare. If the land is in excess of ½ hectare, the excess portion will generally not be considered to be part of your principal residence and will not be covered by the exemption. There is an exception to this general rule if you can make a case that the excess portion was necessary to the use and enjoyment of the housing unit as a residence. This could possibly be the case if there was a minimum lot size restriction in effect at the time the property was acquired. However, recreational appendages, such as a stable for your children’s ponies, would not be considered necessary to the use and enjoyment of the housing unit.
For Canadian tax purposes, there is also no minimum period for which you have to own the property. In order to designate it as your principal residence for a particular year, you need only have inhabited it at some time during that year. As a result, you have the choice of designating a seasonal residence such as a cottage instead of your primary residence if that would be more beneficial. However, the occupancy requirement must be met for each year that you want to make the designation. For example, if you owned a property from 2003 to 2012, but only occupied it in 2003 and 2004, you would only be able to designate it as your principal residence for two of the ten calendar years during which you owned the property. When determining the amount of your exemption, you are allowed an additional freebie year in the proration calculation, so that in this example 30 per cent of the gain would be exempt, calculated as (2 + 1) ÷ 10.
Unfortunately, you can only claim one property as your principal residence regardless of how many properties you might have occupied during the year. For 1982 and subsequent years, you are also limited to one per family unit. A “family unit,” for this purpose, includes your spouse or common-law partner (unless you were separated throughout the year) and children under 18 who are not married or in a common-law relationship. So if you do have more than one property that you can designate, you have to make a choice. However, it does not have to be made on an annual basis. You can wait until you sell one of your properties and decide then for which of the years you owned it you want to make the designation.
If you convert a property from personal-use to an income-producing use, you are deemed to have disposed of it for its fair market value at that time. This would happen if you stopped living in your home and started to rent it out. However, you can elect for the change of use not to have occurred. This election, which is called a 45(2) election, also allows you to continue to designate the property as your principal residence for up to four years even though you are no longer occupying it. This four-year period is extended to six when you have moved as the result of a relocation by your employer. However, you must still report the rental income from the property and you cannot claim a deduction for capital cost allowance if you want the election to continue in effect. The election must be made with your tax return for the year in which the change of use occurs.
A deemed disposition will also occur if you convert a rental property into your principal residence. In this case you can make a parallel election under subsection 45(3) which will defer the capital gain resulting from the deemed disposition until you actually sell the property. You will also be able to designate it as your principal residence for up to four years prior to the deemed disposition. The election is made in the year in which you ultimately dispose of the property. Again it will only be allowed if you never claimed capital cost allowance during the years you were renting it out.
The Canada Revenue Agency provides Form T2091 Designation of a Property as a Principal Residence by an Individual for designating a property as your principal residence. However, the form only has to be filed if there is a capital gain to be reported on the property in the year you dispose of it. If you are able to designate the property as your principal residence for all the years you owned it, there will be no capital gain to report and Form T2091 will not be necessary.
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