Is Your House Sale Really Tax-Free?
David Christianson, CFP, R.F.P., TEP
With the tremendous increase in house prices in most markets across Canada over the last 10 years, exceeded only by the soaring values of recreational properties, getting the capital gains tax free has become more and more important.
Most of us know that when we sell the house in which we live, the capital gain is exempt from income taxes. This is called the principal residence exemption.
The exemption does not apply if we sell a rental property or a second residence. In those cases, half of the gain must be claimed as income and be taxed at the taxpayer’s marginal income tax rate.
The maximum rate of tax on such a gain is therefore about 23%.
But what are the rules surrounding the principal residence exemption? If you own more than one residential property, can you decide which one applies? Did you know that a form (T-2091) may need to be filed with CRA when you sell a principal residence?
First of all, what is CRA’s definition of a “principal residence”?
Thankfully, it is quite broad. It must be a housing unit (house, condominium, cottage, mobile home, trailer or even houseboat), a leasehold interest or capital stock of a cooperative housing corporation.
The housing unit must have been ordinarily inhabited by you, your spouse or common-law spouse, your former spouse or common-law spouse, or your child, which is very broadly defined here. The unit can also be owned by a trust, if normally inhabited by one of the qualifying people.
Generally, only one half-hectare of surrounding property can be included, unless “necessary for the use and enjoyment of the land.” There are some court cases on this point if you are in that situation.
In all cases where someone has multiple properties and a lot of dollars at stake, I strongly recommend consulting a professional, likely an accountant or tax lawyer, who is fully versed in this area. It is much more complex than you expect, until you do the research.
You can choose which property to designate after one or more is sold, but you can only claim the exemption on one residence per calendar year per family. For example, let’s say that you bought your house in 1988 for $100,000, lived in it since then, and sell it in 2008 for $310,000. The gain is $210,000, half of which would have been taxable if this were a rental property. However, it qualifies for the principal residence exemption.
Now, let’s make it a little more complicated, and assume that you bought a cottage in 1998 for $100,000 and it’s now worth $400,000. What would happen if you sold it, as well, in 2008?
Since the gain on the cottage is greater, you would want to shelter all of it, so you would declare it as your principal residence from 1998 to 2008, inclusive.
That leaves 1988 to 1997 available for the house. Dividing those 10 years by the 30 years of ownership means that one third of the gain is sheltered by the exemption.
Here is the math – the gross gain was $210,000, half of which ($105,000) is taxable. Two-thirds of this, or $70,000, must be added to the taxable income of the person(s) who owned (actually, “paid for”) the property.
Here’s another wrinkle - for years prior to 1982, two principal residences were allowed per family. So, if the cottage had been inherited, let’s say, back in 1971, then the first ten years of ownership, divided by the total years of ownership, would be sheltered, as well. (There is no tax on the gain prior to 1971, as there was no capital gains tax then.)
In the real world, we see lots of examples where the house will be sold and the cottage kept, perhaps to pass on to the next generation. In this case, one must decide whether or not to claim the exemption on the sale of the house or save it for the later disposition (often on death) of the cottage.
Remember, as well, that if you sold houses along the way and did not pay tax on their gains, you used up the exemption for the years you owned those houses. You must file Form T-2091 to declare the capital gain; otherwise you have chosen the principal residence exemption by default.
If you have converted a house to a rental property or back, you likely disposed of that property for tax purposes (called “change of use”) and should have claimed that.
Now you see why I suggest professional help. But, don’t worry; careful planning can help you hold on to most of the cash you get on the sale of your valuable properties.
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This article originally appeared in the Winnipeg Free Press on Friday, January 11, 2008
David Christianson is a fee-only financial planner and investment counsel with Wellington West Total Wealth Management Inc. His column, ‘Dollars & Sense’ appears Fridays in the Winnipeg Free Press