New rules for the capital gains Principal Residence Exemption

Posted on February 17th, 2017

Changes to the Principal Residence Exemption (PRE) were announced last year on October 3.

The PRE allows a home owner an income tax exemption on capital gains they realized when they sell their designated principal residence as defined in the Income Tax Act 40(2)(b).

Before 2016, the Canada Revenue Agency (CRA) did not require the home owner to report when they claimed a full exemption for a capital gain under the PRE rules.

Effective January 1, 2016, the CRA requires all dispositions of residential real estate to be reported on Form T2091. Dispositions include a sale, a gift, a death or a change of use.

Owners can claim only one principal residence per year and must provide a description of the property  and details about the date of purchase and the date of sale on Schedule 3 of their federal tax return. (Note: this schedule is being modified.)

The PRE capital gains exemption is intended to be available only to Canadian resident individuals and trusts.

A principal residence, according to the Income Tax Act, section 54:

  • must be a housing unit;
  • must be owned by the tax filer either alone or jointly with someone else;
  • must be lived in, “ordinarily inhabited,” by the tax filer or their spouse and children;
  • must be designated as a principal residence; and
  • can’t be income-producing for tax purposes.

Note: flipped homes are not capital property. They’re considered inventory by CRA and profits are business income, which aren’t entitled to the principal residence exemption.

You own two properties
You own a home in a city and also a seasonal residence such as a cottage or ski condo. You can choose to designate the seasonal residence as their principal residence. The seasonal residence can be considered “ordinarily inhabited in the year” even if it is used only during vacations, provided the property doesn’t gain or produce income.

When the seasonal residence is sold, you – the owner – designate it as the principal residence, and you can claim the PRE against the capital gain.

You change a property use
If you downsize, buy a condo, and rent or gifts your home to one of your children, the CRA considers this a “deemed disposition” because the primary use of the property has changed. CRA considers the home sold for tax purposes at the current fair market value in both these cases.

Residence on acreage
If a residence is on acreage larger than half a hectare (1.235 acres), the portion of the property where the home is located is eligible for the PRE. However, if a municipality’s zoning regulations don’t allow the property owner to legally subdivide their land (as in BC’s Agricultural Land Reserve), then the entire property may be eligible.

Residence owned through a trust
Trusts will be eligible to designate a property as a principal residence for a tax year that begins after 2016 only if additional eligibility criteria are met. After 2016, a trust will be required to be a spousal or common-law partner trust, an alter ego trust or a similar trust for the exclusive benefit of the settlor during the settlor’s lifetime, a qualifying disability trust, or a trust for the benefit of a minor child of deceased parents. The trust’s beneficiary who, or whose family member, occupies the residence for the year will be required to be resident in Canada in the year, and will be required to be a family member of the individual who creates the trust.

Changes for non-residents
An individual who wasn’t resident in Canada in the year the individual acquired a residence won’t, on a disposition of the property after October 2, 2016, be able to claim the exemption for that year. This ensures that permanent non-residents are ineligible for the exemption on any part of a gain from the disposition of a residence.

Record keeping
It‘s imperative that property owners keep records of the purchase price and date, invoices and receipts for capital improvements, and the sale price and date for properties they own.

Owners planning to sell a home should get an appraisal report establishing the fair market value of their properties and keep it on file.

CRA information gathering
Using new reporting information, the CRA is now able to track transactions and identify who has claimed PREs for which years, as well as capital gains not reported in the past and whether tax is owing.

Audits, penalties
CRA can audit and levy penalties and interest charges. If your client forgets to claim the PRE in the year they sell their residence, they will be required to amend their return for that year to be eligible for the PRE. There are late designation penalties.

Always get legal and accounting advice.

Learn more
Canada Revenue Agency, Calculating and reporting your capital gains and losses.
Federal Department of Finance, Technical Backgrounder.
Federal Department of Finance, Notice of Ways and Means Motion to amend the Income Tax Act.
Kim G.C. Moody, Significant changes to the Canadian Principal Residence deduction.

Sources
Canada Revenue Agency
Real Estate Board of Greater Vancouver