A res­i­dence ex­emp­tion run­down

Don’t let tax­man take you be­hind the wood­shed over prin­ci­pal res­i­dence ex­emp­tion

Kingston Whig-Standard - - BUSINESS - JAMIE GOLOMBEK

One of the most valu­able tax breaks Cana­di­ans have is the abil­ity to claim the prin­ci­pal res­i­dence ex­emp­tion (PRE) on the sale of a home. The PRE pro­vides home­own­ers with an ex­emp­tion from tax on the cap­i­tal gain re­al­ized when you sell the prop­erty that you have des­ig­nated as your prin­ci­pal res­i­dence.

Re­cent changes to the Canada Rev­enue Agency’s re­quire­ments now re­quire you to re­port the sale of your prin­ci­pal res­i­dence on your tax re­turn. The des­ig­na­tion of your prin­ci­pal res­i­dence is re­ported on Sched­ule 3 of your re­turn and you must also com­plete the ap­pro­pri­ate sec­tions of Form T2091 (IND), Des­ig­na­tion of a Prop­erty as a Prin­ci­pal Res­i­dence by an In­di­vid­ual.

Un­der the In­come Tax Act, in or­der for a prop­erty to qual­ify as your prin­ci­pal res­i­dence for a par­tic­u­lar tax year, four cri­te­ria must be sat­is­fied: the prop­erty must be a hous­ing unit; you must own the prop­erty (ei­ther alone or jointly with some­one else); you or your spouse or kids must “or­di­nar­ily in­habit” the prop­erty; and you must “des­ig­nate” the prop­erty as a prin­ci­pal res­i­dence.

Note that a sea­sonal res­i­dence, such as a cot­tage, cabin, lake house or even ski chalet can be con­sid­ered to be “or­di­nar­ily in­hab­ited in the year” even if you only use it dur­ing va­ca­tion pe­ri­ods “pro­vided that the main rea­son for own­ing the prop­erty is not to gain or pro­duce in­come.”

The statu­tory def­i­ni­tion of “prin­ci­pal res­i­dence” lim­its the amount of land that qual­i­fies for the ex­emp­tion to half a hectare (one hectare con­tains 2.47 acres) un­less the tax­payer can show that the ex­cess land was nec­es­sary for the use and en­joy­ment of the hous­ing unit. This “half-hectare rule” was the sub­ject of re­cent tax case in which the tax­payer at­tempted to claim the PRE on the 2012 sale of a por­tion of her prop­erty. The CRA de­nied the PRE and as­sessed cap­i­tal gains tax, which is why the mat­ter wound up in court.

Be­tween 1985 and 1991, the tax­payer pur­chased four ad­ja­cent pieces of land in ru­ral Que­bec, in four sep­a­rate real es­tate trans­ac­tions, amass­ing a to­tal of ap­prox­i­mately 4.17 acres. Her hous­ing unit was lo­cated on the land ac­quired in the first trans­ac­tion. The other three pieces of land, ul­ti­mately merged to form a sec­ond lot, were used to build a pool, a barn, a garage, a sep­tic field and a sugar shack.

In July 2012, the tax­payer sold 1.47 acres of the prop­erty to the lo­cal mu­nic­i­pal­ity for the ex­pan­sion of the mu­nic­i­pal aque­duct. The prop­erty sold was a wood­lot rep­re­sent­ing 33 per cent of the sec­ond lot. She re­ceived $100,000 for this piece of land which she had ac­quired in 1986 for $500. Need­less to say, she did not re­port the cap­i­tal gain on her re­turn, main­tain­ing that the PRE should ap­ply. She ar­gued that the wood­lot sold was “the main source of wood used to heat (her) house” and thus was in­te­gral to her use and en­joy­ment of the prop­erty.

The CRA dis­agreed and re­assessed the tax­payer, adding a tax­able cap­i­tal gain of nearly $50,000 to her in­come for 2012, main­tain­ing that the “dis­po­si­tion of 1.47 acres of land im­me­di­ately con­tigu­ous to the hous­ing unit was in ex­cess of half a hectare and that ex­cess did not con­trib­ute to the use and en­joy­ment of the hous­ing unit as a res­i­dence,” as re­quired by the statute.

Thus, the only is­sue be­fore the court was whether the piece of land sold was ac­tu­ally nec­es­sary for the use and en­joy­ment of the hous­ing unit as a res­i­dence.

The judge re­viewed the usual cri­te­ria which some­times can al­low a piece of prop­erty greater than a half hectare to qual­ify for the PRE. In this case, the lot sold did not in­clude the house or any other build­ings which would have con­trib­uted to the use and en­joy­ment of the hous­ing unit by the tax­payer. The three sub­se­quent land pur­chases af­ter the ini­tial trans­ac­tion “were not made by ne­ces­sity for the use and en­joy­ment of her hous­ing unit but rather as a choice of life­style.” The land sold was not re­quired in or­der to pro­vide the tax­payer with ac­cess to and from a pub­lic road and the lo­cal mu­nic­i­pal­ity does not have any reg­u­la­tion re­quir­ing that a hous­ing unit res­i­dence must be built on a lot that ex­ceeds a half hectare.

In her de­fense, the tax­payer ar­gued that her hous­ing unit is equipped with a wood heat­ing sys­tem, an elec­tri­cal sys­tem and a gas fire­place and that hard­wood cut on her prop­erty is nor­mally suf­fi­cient to heat her house dur­ing the win­ter. She said that oc­ca­sion­ally, she had to pur­chase sup­ple­men­tary wood to heat her house which was poorly in­su­lated when she ac­quired it.

Yet, in court, the tax­payer could not pro­vide any de­tailed in­for­ma­tion con­cern­ing the heat­ing sys­tem now in place in her house nor the type and quan­tity of wood cut ev­ery year from her prop­erty to heat her house and the sugar shack.

The judge there­fore con­cluded that the tax­payer could not es­tab­lish “on a bal­ance of prob­a­bil­i­ties” that the land sold, which rep­re­sented 33 per cent of the to­tal area of the prop­erty, was nec­es­sary for the use and en­joy­ment of her hous­ing unit as a res­i­dence. In fact, she still kept 2.7 acres with a wood­lot on it.

The judge felt that the land sold was not nec­es­sary to ful­fill its func­tion as a res­i­dence. As the judge wrote, “A sim­ple state­ment that wood was cut on the piece of land sold, to heat her house, is not suf­fi­cient to al­low the (tax­payer) to meet her bur­den of proof that the piece of land was nec­es­sary for the use and en­joy­ment of her hous­ing unit as a res­i­dence.”

As a re­sult, the CRA’s as­sess­ment was con­firmed and the tax­payer was re­quired to in­clude the tax­able cap­i­tal gain in her 2012 in­come.


Un­der the In­come Tax Act, in or­der for a prop­erty to qual­ify as your prin­ci­pal res­i­dence for a par­tic­u­lar tax year, cer­tain cri­te­ria must be sat­is­fied.

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