As the “Sold” signs go up and the moving vans get rolling in the busy summer real estate season, there’s one thing most people often forget: the tax implications. Actually, that’s only a partial answer. Nothing is simple when it comes to taxes, but there are clear ways to avoid the tax traps that lie in wait for unprepared home sellers.
When selling a house, we often assure ourselves that the principal residence exemption will spare us from having to pay capital gains tax. But this exemption is not as simple as you may think. So here’s a summary of some of the more important rules that can throw you offside of the principal residence exemption.
In order to take advantage of the exemption, certain requirements must be met:
* The home must be ordinarily occupied for personal use by you, your spouse or former spouse, or a child at some time during the year.
* To claim the principal residence exemption on a large lot (over l 1/2 hectare –about 1 1/4 acres), you must be in a position to establish that any land over half a hectare is necessary for the “use and enjoyment” of your home.
* Restrictions will also apply if part (or all) of your home is rented out or is not used by a family member, or if you have not been resident in Canada throughout the period of ownership.
* As a general rule, a family can claim the principal residence exemption on only one home at a time. The second home is more of a problem. To stop you from trying to claim a separate exemption by putting it in the name of a child, rules are put in place that restrict children from claiming that exemption unless they have reached the age of 18 in the year, or are married.
Most people think of the principal residence exemption as a black-and-white matter: Either you qualify to sell tax-free or you don’t. Actually, this is not the case. When you sell your home, you must calculate the gain on your residence just like you would any other capital gain. Then the principal residence exemption itself reduces your gain.
Moreover, eligibility for the exemption is on a year-by-year basis, which might come as a surprise to many. The more years you qualify relative to your total period of ownership, the more your gain gets reduced. To be more precise, use the basic formula that normally applies:
[(Number of years home is principal residence + 1) x capital gain] / Number of years home is owned.
As you can see, to get the tax reduction, you must designate the home as principal residence on a year-by-year basis. If your gain is completely covered by the principal residence exemption, as is often the case with your own home, it is not necessary to file the designation form.
Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-editor of various CCH Canadian Ltd. tax publications. A version of this article first appeared in The TaxLetter, published by MPL Communications Ltd., © 2012, reprinted with permission.
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The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
