Changes to the Principal Residence Exemption
By: Nizam Shajani, CPA, CA, MBA, Partner
When you sell your home, usually you do not have to pay tax on any gain from the sale because of the principal residence exemption. This is the case if the property was solely your principal residence for every year you owned it. However, there are new reporting requirements that if missed, will result in penalties.
What is a Principal Residence?
The property must meet all the following conditions to qualify as a principal residence:
- It is a housing unit, leasehold interest in a housing unit, or a share of the capital stock of a co-operative housing corporation you acquire only to get the right to inhabit a housing unit owned by that corporation;
- You own the property alone or jointly with another person;
- You, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year;
- You designate the property as your principal residence.
This can include a house, cottage, condo, apartment, trailer, mobile home or houseboat and does not have to be located in Canada.
Changes to the Principal Residence exemption
Before 2016, if you sold your property and it was your principal residence for every year owned it, you did not have to report the sale to claim the principal residence exemption.
This changed with the March 2017 federal budget. As a follow up, on June 2017 CRA issued a news release (The Government of Canada cracks down on tax cheating in real estate transactions) underlining that from April 2015 to March 2017 CRA completed over 21,000 files related to real estate and assessed over $329 million in previously unreported income and applied over $17 million in penalties.
As part of their plans to continue enhancing compliance procedures in the real estate section, there are new reporting requirements for the sale of a principal residence.
The New Reporting Requirements
For dispositions in 2016, you had to report the sale and designate the property on schedule 3 (Capital Gains or Losses). For disposition in 2017 and later years, in addition to the schedule 3 reporting – you must complete form T2091(IND), (Designation of a Property as a Principal Residence by an Individual). Information on this form includes the address of the home, the year purchased and the proceeds from the sale.
Change in Use
You need to consider if there is a deemed disposition from a change in use even if you did not sell your property. A change in use occurs when the principal residence no longer meets the criteria for a principal residence.
This may occur when the property is fully rented, the owner passes on or is no longer a resident of Canada.
For example, when a property is changed from a personal use to an income producing use there is a deemed disposition. The new rules would require the disposition be declared on your tax return. The fair market value from the date of change in use would be used as the new cost base of that property and any gains/losses from that date would be taxable.
There is an option to file an election (45(2) which provides for no deemed disposition when a property is changed from a personal use to an income producing – this is due in the tax return for the year in which the change occurred.
Partial Change in Use
When a portion of the principal residence begins to be used for business or rental purposes, that portion of the property is deemed disposed of and required for fair market value (45(1)(b). However, CRA has noted (Folio S1-F3-C2) that it is their practice not to apply the deemed disposition rule, but rather to consider that the entire property retains its mature as a principal residence. The following conditions must be met:
- Income-producing use is ancillary to the main use of the property as a residence
- There is no structural change to the property and
- No CCA is claimed on the property
This works in cases where one or more rooms are rented, there is a child care business in the home or there is an office or workspace within the home. In such cases you may claim the revenue and deduct related expenses other than CCA.
What to do if you missed the reporting deadline?
The principal residence exemption will only be allowed if you report the disposition and designate the property as your principal residence on your tax return. If you forget to make this designation in the year of the disposition, it is important to amend your return for that year. The late designation will likely be accepted; however, penalties will apply.
Note that amounts filed with CRA normally are subject to audit for a period of three years – however there is no limitation to how far back CRA can go for missed filings. Missed filings may also raise CRA’s curiosity as to what else may have been missed and subject you to a more in-depth audit.
Penalties for Not Reporting
If the reporting is not made, you will lose the principal residence exemption. A late filing or an amended return can be made, however there will be late filing penalties of $100 per month to a maximum of $8,000.
Not reporting the sale of your principal residence is now amongst the top errors to avoid during tax time. Remember to report this sale on schedule 3 and form T2091(IND). There are no taxes on this sale, however there are penalties for not reporting.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.