Deciding principal residence designation not easy task
A retired couple named Kyle and Irene plan to sell their house and move into a condo. Five years later, when Kyle turns 80, they plan to sell their cabin at the lake.
They will sell their city house for $500,000. With prices rising, they could sell their cabin at the lake for $500,000.
They want to use the principal residence exemption. Since they “ordinarily inhabit” both their city house and their cabin at the lake, either property can qualify. How do they decide which one to designate as
principal residence?
Track both cost bases
Knowing they must report taxable capital gains on one of the properties, Kyle has calculated the Adjusted Cost Base (ACB) of both. Because the cabin has a smaller ACB, the cabin’s capital gain should be about $75,000 bigger than the city house capital gain.
The cabin’s cost is smaller because Kyle and Irene bought a vacant lot and built the cabin themselves in 1986. On their 1994 income tax returns, they made their capital gains elections.
According to their accountant, if they designate the cabin as their principal residence for the years from 1994 until they sell in 2018, they could save roughly $75,000 income tax.
Kyle and Irene understand that they are only allowed to designate one of the two properties as their principal residence per year for those 25 years. Not claiming the principal residence exemption for their city home means they’d have to pay about $60,000 tax on the taxable capital gain on their city home for 2013.
Where will they find the $60,000 cash needed to pay their income tax bill? They need the full $500,000 house sales proceeds to pay for their new condo. They prefer not to make a fully taxable RRIF withdrawal to pay the tax bill. Fortunately, Kyle and Irene have TFSAs, each worth $30,000. They can make tax-free TFSA withdrawals to pay the capital gains tax.
They are debating the question: Is it worthwhile to pay $60,000 capital gains tax on the city house for 2013 in order to save about $75,000 tax on the cabin capital gain in 2018? Because they are comparing today’s dollars to future dollars, their financial planner would phrase the question another way. If we have two per cent annual inflation for the next five years, the 2018 tax bill is really worth about $67,000 in today’s dollars. They are leaning toward paying the smaller capital gains tax bill for 2013.
Designation form
If they decide to designate the cabin as their principal residence, there is no need to complete and file form T2091 (Designation of a Property as a Principal Residence by an Individual). They would simply report the capital gain on the sale of their city house on Schedule 3 of their 2013 tax returns. For 2018, they simply would not have to report any capital gain on the cabin sale, without filing any form T2091 for that year either.
OAS clawback
Reporting a big capital gain means Kyle and Irene will each have 2013 net incomes over $114,815, which would cause each of them to have to repay the full amount of their OAS for tax year 2013. That adds about $13,000 to their 2013 tax bills.
Defer tax
In most cases it’s better to pay tax later rather than sooner. Simply designate the first property sold as the principal residence and defer the tax bill until the year of the sale of the second property. Will the cabin actually rise in value as much as Kyle and Irene expect?
If you are choosing between designating your city home and a vacation home as principal residence, see your accountant.