For many Canadians, their home is their biggest asset. Owning a home also comes with friendly treatment from the Canada Revenue Agency (CRA); through what's known as the principal residence exemption (PRE), people are generally exempt from paying capital gains tax when they sell their primary homes.
The PRE isn't going away. But recent rule changes announced by the Government of Canada have restricted who can qualify for the benefit. And for those who are still able to receive the PRE, the CRA has introduced new reporting requirements when a home is sold.
Background
Usually, when you sell a capital asset, such as a stock, and record a gain, that gain is subject to tax. However, that has not usually been the case with regards to one's personal residence in Canada. Each "family unit," which encompasses parents and children under 18, is able to claim one principal residence per year.
A family does not actually have to live in a house for the entire year to claim the exemption. Rather, the exemption is available to the family if the taxpayer, his or her spouse or one of their children "ordinarily inhabited" the home that was sold for a capital gain. That said, the CRA's definition of "ordinarily inhabited" is quite generous. It allows, for example, a cottage or other vacation property to be designated as a principal residence so long as a member of the family occupied it in a particular year.
Of course, the fact you can only designate one residence as your primary home per year does come with questions. What if you have to move across the country mid-year? In this event, for example, you might be selling one home in Toronto and purchasing a condo in Edmonton. Fortunately for taxpayers, the CRA has long recognized this potential issue and permitted a way around it. Through what's known as the "one-plus rule," Canadians have been able to effectively claim two principal residences in a year in which they moved.
What's changing
In early October, the federal Department of Finance announced changes to the way the PRE would operate. The first two measures were intended, in the Department's words, to "better ensure that the principal residence exemption is available only in appropriate cases."
- An individual who was not a resident of Canada in the year he or she acquired a property will not be able to claim the PRE for that year when the property is ultimately sold. "One of the purposes of the new legislation is to reduce the tax benefit of the exemption afforded to those non-residents as the government tries to reduce the number of actors fueling the rising housing market," says Robert Handelman, vice-president of tax and wealth at Natixis Global Asset Management.
- Following the tax year 2016, trusts will only be able to claim a property as a principal residence if they meet certain eligibility requirements. "The new rules have restricted situations in which a trust can now qualify for the PRE when it owns a property that may ordinarily qualify for such," says Handelman. "Previously, there was a much broader range of trusts that could qualify for the exemption. Under the new rules, the only trusts that will be eligible for the exemption are alter ego, spousal, joint spousal, qualified disability trusts, and trusts for minor children of a deceased parent."
The new rules also mandate increased disclosure by Canadians wishing to claim the PRE. Prior to the rule change, taxpayers did not have to make a filing with the CRA when they sold their principal residence in order to qualify for the exemption. They simply didn't declare the capital gain or loss on their income tax return.
For tax years beginning after Oct. 2, 2016, the government "will require a taxpayer to report the disposition of a property for which the principal residence exemption is claimed." This disclosure is to be made on a Schedule 3 Form and must list basic details of the property, such as the year it was acquired, a description of the residence and the purchase and disposition prices.
The bottom line
For most homeowners, the crucial matter with these new rules is that in order to claim the PRE, you now have to seek it proactively by making a filing with the government for the year in which the property was sold. If you do forget to claim the PRE for the year in question, the CRA will allow you to amend your return, but you could be subject to a penalty of either $100 per month you are late in filing or $8,000, whichever is less.
