In October 2016, the Federal Government announced changes to the “principal residence exemption” (PRE), one of the best-known “tax breaks” under the Income Tax Act (Canada). These changes will likely affect you.
To begin, what is the PRE? The PRE is a benefit that generally provides someone with an exemption from the requirement to pay income tax on the capital gain realized when he or she sells the real property that is his or her “principal residence.”
To be a “principal residence” the real property must be ordinarily used and occupied by the owner(s), so it could include a seasonal property (like a cottage), but not a property that is rented out to tenants or a commercial property.
Couples and single people only enjoy one PRE (i.e. couples don’t get two, so the husband can’t use “his” PRE to shelter the cottage, and the wife “her” PRE to shelter the main home).
Basically, the PRE can mean that if you bought your home for $10,000 in the 1960s and it’s now worth $1,000,000, there will no income tax due on that $990,000 gain in value when you die or sell your home, provided that you qualify for the PRE.
Generally, the PRE will apply for each year the property is designated as that person’s principal residence. If someone sells his or her main home, but almost immediately buys a replacement home, then the so-called “plus one” rule can kick in, and that owner can enjoy the full PRE on his or her old home, while also enjoying the full PRE on his or her new home.
The Federal Government has now tightened reporting requirements, saying that the updates “better ensure that the [PRE] is available only in appropriate cases, and in a manner consistent with the Canadian resident and one-property- per-family limits” and they “improve tax fairness and the integrity of the tax system.”
Previously, the Canada Revenue Agency (CRA) did not require people to report sales of their principal residences if the properties were those people’s principal residences for every year they owned them. Now, starting with the 2016 tax year (generally due by late April 2017), people who sell their principal residence will be required to report basic information about the sale on their income tax returns in order to claim the full PRE. As such, if you sold your principal residence on or after January 1, 2016 (even if you immediately bought a replacement home), you should take care to make sure that your income tax return is prepared correctly.
This new obligation to report extends to “deemed dispositions” of a principal residence as well. For example, when the sole owner of real property dies, he or she is deemed to have sold the real property for fair market value, as of the date of his or her death. So, if someone dies before he or she sells his or her principal residence, then the deceased’s person’s PRE can still be used, but there is now an obligation on the deceased person’s estate trustee (executor) to report to the CRA. If you are administering an estate which includes real property, you should advise your accountant about this to ensure all reporting requirements are fulfilled.
Other common “deemed dispositions” include turning your principal residence into a commercial or rental property, or turning a commercial or rental property into a principal residence. These changes in occupancy / use of the real property must be reported as well.
What if someone now forgets to report the sale of a principal residence and later wants to claim the PRE? Amended information must be filed with the CRA, but penalties can apply.
What if, for example, you moved to Oakville in 1995 and were using your PRE on your main home from 1995 – 2005, but then you bought a cottage in Muskoka and decided to switch your PRE to the cottage from 2005 – 2010, but after 2010 switched it back to your main home? You were well within your rights to use to your one PRE to partially shelter two real properties; however, that’s exactly what you did – only partially shelter them. If and when your main home and cottage are sold, some taxable capital gains will likely apply to both real properties, because neither of them was 100% sheltered under the PRE during the period of time you owned them. This situation was, in fact, always the rule, but by increasing reporting requirements, the CRA is hoping to identify taxpayers who were using the PRE inappropriately.
Two other big targets of the Federal Government are “non-resident” homeowners and trusts. Importantly, “non-resident” refers to tax status, not immigration status. As such, a Canadian citizen who moves down to the United States and works there for a few years may be a “non-resident” for Canadian tax purposes, even though he or she still has a Canadian passport.
A real property in Canada that is owned by a non-resident may qualify as that non-resident’s principal residence, but eligibility for the PRE will be limited by the 1) number of years the owner was actually resident in Canada, and 2) the number of years the property was actually his or her principal residence. These limits can also affect the “plus one” rule above. Homeowners who are not always resident in Canada are strongly encouraged to review their situation with an accountant.
Lastly, updates to the PRE can affect real properties held in trust. Previously, if a real property was held in trust and the property was ordinarily occupied by a beneficiary of the trust, then the trustees of the trust could possibly designate the property as that beneficiary’s principal residence. This can still happen, but it has effectively been limited to certain kinds of trusts, namely: 1) alter ego trusts, joint spousal trusts and joint common-law partner trusts (created by people over age 65); 2) trusts which are not alter ego trusts, but are also exclusively for the benefit of the settlor (creator of the trust) during his or her lifetime; 3) spousal trusts and common-law partner trusts (e.g. under a Will); 4) qualified disability trusts; and 5) trusts for a minor child or children (under age 18) of a deceased parent or parents.
Trusts which do not fit into those categories above (e.g. a cottage trust established for the purpose of ensuring that multiple generations get to enjoy the property, or even situation #5 above when the child or children turn(s) 18) may no longer qualify for the PRE when the real property at issue is sold or when the 21 st anniversary of the trust occurs (since there’s a deemed disposition of capital assets in a trust every 21 years). As such, trustees are strongly encouraged to review their situation with their accountant, because in some circumstances it may make sense to terminate the trust early and distribute the real property out to a beneficiary or beneficiaries.
More information on the PRE and the new changes can be found on the CRA’s website.
The foregoing should not be considered to be legal advice and should not be relied upon as such. Please consult a lawyer to get advice and an opinion on your unique circumstances.