A home is the biggest single investment most of us ever make. Not only does it put a roof over your head, it probably is going to gain in value. But there's an additional, significant kicker that comes from, of all sources, the tax man. When you sell your home for more than you paid for it, the profit is not subject to tax, thanks to the capital-gains exemption on the sale of a principal residence.
The tax-free status is a good reason for young people to jump into home ownership as soon as they can muster a down payment. It's also enough to keep empty-nesters or retirees in the family home or, alternatively, downsize their home equity to a smaller house or condominium, rather than move to a rental apartment.
Of course, continued home ownership during one's retirement years makes sense only if it remains practical to leave a considerable sum of capital tied up in real property, along with paying property taxes and dealing with the ongoing expense and hassle of maintenance and repairs. And in the case of condos, owners face not only ever-increasing condo fees, but also the possibility of substantial capital levies for repairs or renovations to common elements.
But the fact remains: it's hard to beat a tax-free investment that's generally far less volatile than the stock market. Normally, half the profit from the sale of real estate and other capital investments is taxable. So not having to pay capital-gains tax on the sale of a principal residence can produce huge savings over time.
What defines a principal residence? In most cases, it's simply the house, condo or other type of living unit that you call home. But for those who own more than one residential property, things can get complicated. These complexities are due to unexpected, additional generosity on the part of the Canada Revenue Agency, because any property that you make personal use of at any time of the year can qualify as a principal residence.
Moreover, you can assign principal-residence status to whichever home you wish for a given year. The property you designate for a particular year or span of years normally would depend on the market-value history for each property you own.
For example, say you purchased a house in the city in 1990 and then a cottage in 1998. If you are selling the city house now, but your cottage has appreciated more in value since you bought it than has the city house, you could opt to claim the principal-residence exemption only on the city house's increase in value between the 1990 purchase date and the end of 1997, and pay capital-gains tax on the increase in its value from the beginning of 1998. That would allow you to be able to claim the principal-residence exemption on the entire gain in value of the cottage property when the time comes to sell it.
Of course, if the city house gained more in value during certain years after the cottage was acquired, you can opt to apply the exemption in the city for those years, and to the cottage in other years.
When designating multiple principal residences at the time you sell a property -- and possibly paying capital-gains tax, as the case may be -- you will need to be ready to prove to the income- tax authorities what the market values were at the various points in time. While usually different from market values, municipal property valuations can provide benchmarks of changes in value over the relevant time spans.
Use Canada Revenue Agency's Form T2091(IND) to calculate the amount of exemption and any capital gain for a particular property sale. This form need only be filed with your tax return if you are reporting a capital gain resulting from that sale.
There's an additional wrinkle for homes acquired prior to 1982. From 1972, when capital-gains taxation was introduced, through 1981, each spouse was able to designate a separate home as a principal residence. Form T2091(IND) includes provisions for the pre-1982 designations.
Consider the example of a cottage that had been in the family since the 1960s:
- No tax would be payable on the gain in value through the end of 1971.
- From 1972 through 1981, the cottage could be designated a principal residence by one spouse while the city or other home was designated as such by the other spouse during the same period.
- From 1982 onward, the choice would have to be made as to which home to designate as principal residence -- and for which calendar years -- when the time came to sell either property. (Note that, beginning in 1993, the definition of spouse included a common-law partner as defined by the Income Tax Act.)
If you made an election in regard to the gain in the property's value under the $100,000 capital- gains exemption that was available to individual taxpayers before Feb. 23, 1994, you will need to take this into consideration when computing a capital gain -- or making use of the principal- residence exemption -- on the sale of a residential property. Use CRA Form T2091(IND)-WS for this purpose.
Note that if you are simply claiming the principal-residence exemption on one home, without designating another property during the time you owned it, you do not have to report anything in regard to the sale of this property on your income-tax return. You do not need to complete and attach the above-mentioned forms.
There are some restrictions as to what qualifies as a principal residence. If the property was used exclusively as a rental property or for other business purposes, it won't qualify for the exemption. And, in the case of a large property, normally only the half-hectare of land surrounding the house can be included as part of the principal residence. However, if you can prove that some or all of the overall lot is necessary to the "use and enjoyment" of the home, then that land also can be included as part of the principal residence. For example, this might be due to a minimum building-lot size as defined by the municipality, because the access road crosses the entire property, or because a well is located outside the half-hectare limit.
Also, remember that a property is allowed to be transferred to a spouse upon the owner's death, without capital-gains tax being immediately payable. Tax on the entire amount of the property's gains in value would be payable upon the second spouse's death -- unless of course the principal-residence exemption is available for that property.
