From determining potential deductions to figuring out how much we should put in our registered retirement savings plans (RRSP) or tax-free savings accounts (TFSA), tax season already brings up more than its fair share of thorny questions. And changes to tax rules may have left many Canadian homeowners even more confused. But fortunately, complying with the rules doesn’t have to be complicated.
Here’s what you need to know about the changes to the principal residence exemption (PRE) rules so you can rest easy this tax season.
What are the new tax rules about principal residences?
The new rules were introduced in October 2016. They changed the reporting requirements concerning the sale of your principal residence. Before 2016, if you sold your principal residence, you did not have to report the sale on your income tax return, or pay tax on any capital gains from the sale.
What do I need to do as a homeowner?
The good news is that you still don’t have to pay capital gains taxes when you sell your principal residence (provided you’re a Canadian resident and otherwise satisfy certain requirements under the new rules). But now, you need to include some details about the sale on your tax return. You’ll need to provide the year you bought your principal residence, its address and sale price. The form to use is included in your tax package (Schedule 3 of your tax return). There has also been a change to the way non-residents calculate the length of time they’ve owned their principal residence.
What is a principal residence?
According to the Canada Revenue Agency (CRA), a “principal residence” is any residence ordinarily inhabited by you or a family member in the year. It doesn’t have to be a house. It could be a condominium unit, cottage, mobile home or even a houseboat. There’s no need to live in the property for the entire year, and even short periods of time during the year (like vacations) can suffice. Your principal residence doesn’t even have to be in Canada. But only one dwelling can be a principal residence at a time, and you can decide which dwelling it will be. If you sell a property that you haven’t designated as your principal residence, you must report half of any capital gains from the sale and pay tax on them.
So why are there new rules?
The new rules were designed to close a loophole. In theory, the change to the way property owners calculate the number of years they owned a property should reduce the number of foreign investors and house-flippers who previously avoided paying capital gains taxes on the sale of residential real estate by claiming their properties as their principal residences. The reporting requirements also let the CRA monitor compliance with the rules, to ensure that only those entitled to the PRE can use it. While the rules were changed for the 2016 tax year, they will only affect you when you sell your principal residence. If you sold in 2017, you need to understand the rules now; if you don't sell you home until 10 or 20 years from now, the rules will be well established by then, but they'll still be new for you.
What are capital gains taxes?
If you sell stock, real estate and shares (common types of “capital property”) for more than you originally paid, the difference is a capital gain. You’re taxed on 50% of the gain at your marginal tax rate, which differs depending on your income.
What happens if I don’t report?
It’s important to report the sale of a principal residence on your tax return for the year of the sale, starting with the 2016 tax year. If you don’t, you may be liable for capital gains on the sale, plus late charges and interest. You may ask the CRA to allow you to amend your tax return to designate your home as a principal residence. But if the CRA agrees, a penalty may apply. The penalty is $100 per month for each month you’re late, to a maximum of $8,000. Because the rules is still quite new, CRA may show a little leniency towards you if you don't report - but don't count on it.
The bottom line
While the CRA can’t realistically check on every individual Canadian residence, it does monitor trends. The CRA can also access real estate sales information and will likely notice if you have a habit of frequently buying and selling homes.
Paying taxes is rarely a fun process. But getting audited? Far more painful.