printable copy: Principal Residence Election [PDF, 3 pages, 122 kb]
Capital Gain Exemption. A Powerful Planning Tool
Hélène Marquis, LL.L., D. Tax, Fin. Pl., TEP
Senior Planning Consultant
Affluent Insurance Solutions
Sun Life Financial
Canada’s capital gain exemption on a family’s principal residence offers advisors a powerful resource to improve the financial wealth of their clients. But the rules have changed over the years and clients need to understand if they qualify under the old rules and when the new rules apply.
From January 1, 1972 to December 31, 1981, each family member could claim a capital gain exemption on a principal residence and, in some circumstances, your clients may still benefit from owning property dating back that far.
Since 1982, the rules on principal residency limit the election to one residence per family (except for former spouses, married children or children over 18).
The Income Tax Act (ITA) defines those who qualify as:
Individuals who are Canadian residents.
Owners or co-owners (joint tenancy or tenancy-in-common) of a housing unit.
Personal trusts also qualify as owners.
The election can include the land on which the residence is located, limited to one-half hectare. A larger property may qualify when it proves necessary for the use and enjoyment of the residence.
Qualifying Housing Unit
A unit in a duplex.
A unit in an apartment building or a condominium.
A mobile home.
A leasehold interest in a housing unit.
A share in a co-op that allows the owner to live there.
The owner, the spouse or child must usually live in the residence although the rules don’t specify the length of time - an annual vacation may be enough. The goal is to ensure the property is not used primarily for gain or to produce income.
Incidental Rentals are Okay
Canada Revenue Agency (CRA) allows owners to earn incidental rental income from the principal residence without contravening the rules.
Location can be Anywhere
The residence can be anywhere, even outside of Canada. Assuming all other requirements are met, an owner can sell a property abroad and still take advantage of the capital gain exemption here in Canada. However, there may be country-specific taxes and/or fees that apply when the property is sold.
When you sell a principal residence, you must report the sale on that year’s tax return even though its appreciation is free from taxes.
$100,000 Capital Gain Exemption from 1994
On February 22, 1994, the government removed the $100,000 capital gains exemption, but allowed taxpayers to file an election to claim this exemption against capital gains accrued to that date. If a taxpayer now sells that property, the 1994 election will be applied to reduce their capital gains.
A taxpayer owns two properties - a family home and a cottage. The family considers the family home as their principal residence and will benefit from the tax-free capital gain when they sell the property.
In 1994, the family applied to safeguard $100,000 of the appreciated value of their cottage as allowed under the capital gains exemption rules of the time.
In 2004, the family sells the cottage for $275,000 that they bought for $50,000. Their capital gain will be only $125,000 of the appreciated value since they protected $100,000 back in 1994.
However, if the family keeps the cottage, and later classifies this as their principal residence, they would not pay tax on gains arising in the years it was a principal residence. When they eventually sell it:
part of the gain would be protected by the 1994 $100,000 capital gains exemption
part would be protected under the principal residence exemption
and any remaining part not covered by these exemptions would be exposed to tax.
As mentioned earlier, from January 1, 1972 to December 31, 1981, the capital gains exemption on a principal residence was available to each family member. Two spouses could each own a residence (cottage and house) and elect it as their respective principal residence to claim the capital gains exemption.
Clients who own property dating back that far must complete an ITA formula to determine if they are subject to any taxable gain on the second property.
Converting to an Income Property
If a principal residence is converted to an income property, the conversion is considered a disposition and triggers capital gain. However, a person can defer the gain and continue to own the property as a principal residence for up to four tax years. During this time, deductions of capital cost allowances are not permitted
What Advisors Can Do
As part of your fact-finding efforts with clients, property ownership and the timing of these purchases are important considerations in developing any wealth management programme during the client.s lifetime and following death.
Find out if a client holds any properties dating back to 1982 or earlier.
Include the timing of property purchases as part of your Asset Protection Plan discussions and in completing an estate plan.
Add property ownership to your presentations and discussions related to estate planning and wealth management.
The information presented here is for your information only. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation or other professional advice to advisors or their clients. Before you act on any of this information on behalf of a client, always have your client seek advice from a qualified professional including a thorough examination of your client’s specific legal/tax situation.