The principal residence exemption revisited
Beginning with 2016 you must report the sale of your principal residence. This column will detail the changes but please speak with your accounting professional with regards to any of these changes that could matter in your own financial world.
In October 2016, the Canada Revenue Agency (CRA) announced administrative changes affecting claims for the Principal Residence Exemption. This exemption applies for each year that you own the property you designate as your principal residence, and allows you to sell it without incurring capital gains tax.
As of the 2016 tax year, individuals who sell their principal residence will have to report the sale on Schedule 3, Capital Gains of their T1 tax return. This will be required for all sales that occur on or after Jan. 1, 2016. Previously, there was no requirement to report the sale if the property met all the conditions to be a principal residence, including being your principal residence for every year you owned it.
These rules will affect homeowners and taxpayers of two or more residences. While the CRA cites its reasoning for these new rules as improved compliance and administration of the tax system, the financial services industry says they are mostly aimed at taxpayers who make a business of flipping houses. Taxpayers who occupy a property for less than a year may not qualify. One of the conditions of obtaining the exemption is that the property must be the taxpayer’s “capital property” (i.e., not a property that was briefly occupied and then sold, and therefore akin to a commodity). It also should not be a building where business is conducted. For example, if you reside in a building where you conduct business, it will be necessary to calculate the gain on the residential portion separately from the gain on the remaining portion of the property.
Calculating the principal residence exemption using the “+1 rule.” The CRA rule/formula allow taxpayers who own and occupy two properties in the same tax year to claim the principal residence exemption. For example, the Smith family bought a condo in 2006, and then sold it in 2012. In the same year, 2012, they bought a house. They later sold the house in 2016. Even though their ownership of the condo and home overlapped, if they designate their properties according to the Principal Residence Exemption, CRA will allow them to claim the exemption for both properties on their 2012 and 2016 tax returns.
Let’s look at the Smiths’ timeline for owning the two properties and claiming the exemption on both properties: In 2006, the Smiths buy a condo, then in 2012, they sell their condo in April and buy a house in May 2012. The Smiths designate the condo as their principal residence for 2006-2011. Due to the +1 rule, they are able to claim the Principal Residence Exemption for the seven years they owned the condo (2006-2012) on their 2012 tax return. In 2016, the Smiths designate the house as their principal residence for 2012-2015. Due to the +1 rule, they can get the full capital gain exemption for the five years they owned the home (2012-2016) on their 2016 tax return. It should be noted that under the new rules, the +1 rule is no longer available to non-residents during the year they buy a Canadian property. Those individuals will not be able to claim the exemption for that +1 year.
If you fail to report the sale of your principal residence, you can do so by filing a late-filing form. Please note, the new rules allow the CRA to reassess beyond the normal three-year assessment period when a sale has not been reported. The late-filing itself may be considered an audit flag by the CRA, and could result in an audit. A penalty may apply for late-filing. It could be the lesser of the following amounts: $8,000; or $100 for each complete month from the original due date to the date your request was made in a form satisfactory to the CRA.