Tax issues when selling your home
One of the few tax advantages we have as Canadians is that gains we realize on the sale of our homes is not subject to tax. Well it’s not as simple as that. In reality the gain on the sale is in fact taxable. The reason why we generally don’t pay any taxes is due to an exemption that potentially reduces the gain to zero. This exemption is called the principal residence election and when fully understood you can maximize the tax savings this exemption provides. This article explains the election and how to best use it to your maximum advantage.
The principal residence election works like this. For every year that you resided in your home you can elect that year as your principal residence and for each year you elect, the gain will be reduced by the fraction of the years you elected to the total number of years you owned the home. Now if you owned only one home at any one time and you elected each of the years you resided there as your principal residence then there would be no taxes to pay on the gain. Administratively the Canada Revenue Agency allows Canadians to not report the sale of their homes since for most; the election would fully offset the gain. It is CRA’s position that when a taxpayer does not report the sale of their home, they have made the principal residence election for all the years they owned it.
Complexities arise when you own more than one dwelling on which you could elect. Other than your home, the types of property that can qualify as a principal residence include: a cottage, a condominium, a mobile home, a trailer or a houseboat. If you own any one of these you could designate it as your principal residence instead of your home provided that you, your spouse or child ordinarily inhabited that property. Even if you inhabit a dwelling for only a short period of time in the year, such as a vacation or weekends to your cottage or houseboat, this would be sufficient for that dwelling to be considered “ordinarily inhabited” in the year.
You may ask why you would elect another property or dwelling as your principal residence instead of your home. The answer to this question depends on your particular situation; however since the principal residence election reduces the gain on the property you elected on then it would only make sense to elect on the property that has the highest gain. It is well known that property values have been increasing in Canada and that lake front cottage property have been on the higher end of this trend. If you own both a home and a cottage then you may be better off to designate the cottage as your principal residence. An example will help clarify.
Suppose you have a home that you have owned for the last twenty years. You purchased it for $100,000 and it is now worth $175,000. Suppose also that you have a cottage that you purchased ten years ago for $30,000 and that it is now worth $100,000. Suppose that you are selling both in the current year. If you designated your home as your principal residence for all the years you resided in it you would not pay any taxes on the $75,000 gain but the gain on the cottage sale would be $70,000 and this would be subject to taxation. You could however designate the cottage as your principal residence and save the tax on its $70,000 gain. Also when you sell your home you could designate it as your principal residence for the first ten years when it was the only property you owned. This means the gain on the home would be reduced to $33,750. This would result in a substantial tax saving.
This example has been simplified. The important thing to realize is that you should carefully examine the principal residence election if you own more than one property and you sell any one of them. If you do nothing in the year you sell your home you will have been deemed to use the principal residence election on it and it would not be available for any other property for those particular years. You could be blindly saving the tax on a very small gain related to your home to pay a much larger amount of tax on a higher gain related to any other qualifying property you own. The rules are more complex than depicted in this article. You should consult your chartered accountant to see what is best for you.
Guy Venne is a Fellow Chartered Professional Accountant and partner with MNP a national professional services firm with an office in Mindemoya. Guy has over 20 ears of experience in accounting, business advisory, information technology, valuations and tax serving individuals and small, medium and large businesses both incorporated and unincorporated throughout Northern Ontario.