Significant Changes to the Canadian Principal Residence Exemption Rules
After the recent announcement from the government of British Columbia introducing a new tax on foreign purchasers for the Vancouver area, the Department of Finance released a proposal to amend the Income Tax Act (the “Act”) on October 3rd, 2016, in an effort to stabilize Canada’s housing market.
Before discussing the changes to the income tax regime, it is important to set out the following background information on the taxation upon the sale of one’s principal residence.
First, Canadian resident individual taxpayers who sell their principal residence and realize a gain may claim a tax exemption when calculating the taxes from their gain. This capital gains tax exemption relies on a formula in paragraph 40(2)(b) of the Act. The formula is only applicable if the individual disposes of a property that is the individual’s “principal residence”.
Second, the definition of “principal residence” is contained in section 54 of the Act. The definition requires the individual taxpayer (or the spouse or common-law partner or child of the taxpayer) to have “ordinarily inhabited” the property. Court cases determine the meaning of “ordinarily inhabited”. The property also has to be a “capital property” of the taxpayer – this means that individuals who purchase and sell properties as a business are not eligible for the principal residence exemption because the properties are likely considered as inventories. Any resulting profits would likely be considered as business income that would not be entitled to the principal residence exemption.
Third, the principal residence exemption for individuals requires the individual taxpayer to file with the Canada Revenue Agency (the “CRA”) a prescribed form, Form T2091. However, the CRA’s previous administrative position was that Form T2091 was not required to be filed for individuals if the principal residence exemption eliminated all of the taxable gain.
There are also specific principal residence exemption rules relating to personal trusts which are outside of the purview of this article.
A Notice of Ways and Means Motion published on October 3, 2016 has set out the following proposed changes:
- Changes to the Principal Exemption Calculation Formula in Paragraph 40(2)(b) of the Act
An individual who is a non-resident of Canada in the year of the acquisition of the principal residence property will be using a slightly different formula to calculate their principal residence exemption of capital gains tax. An individual who is not resident in Canada in the year that the individual purchased a residence will not—on a disposition of the property after October 2, 2016—be able to claim the exemption for THAT year. This new rule applies for properties sold after October 2, 2016. To give an example of this rule, an individual non-resident purchaser who buys and sells a residence in the same year after October 2, 2016 will no longer be able to claim the principal residence exemption for that year. The change in the formula is to prevent a non-resident of Canada from being able to dilute their taxable capital gain on the disposition of a principal residence.
The above new rule does not apply to residents of Canada disposing their principal residence.
- Changes to CRA’s Administrative Position for Reporting Principal Residence Dispositions
Concurrent with the Department of Finance’s announcement, the CRA announced significant changes to its administrative position regarding the reporting of principal residence dispositions. The CRA states the following amongst other things:
Starting with the 2016 tax year, individuals who sell their principal residence will have to report the sale on Schedule 3, Capital Gains of the T1 Income Tax and Benefit Return. Reporting will be required for sales that occur on or after January 1, 2016.
You will complete Schedule 3 and file it with your T1 Income Tax and Benefit Return for the year you sell the property. If the property was your principal residence for every year that you owned it, you will make the principal residence designation in your Schedule 3. In this case, the year of acquisition, proceeds of disposition and the description of the property are the information that will have to be reported. Schedule 3 will be modified accordingly. Form T2091 (or Form T1255) will still be required for the designation in the case the property was not your principal residence for all of the years that you owned it.
- Changes to CRA’s Assessment Period
The CRA is also given authority to assess taxpayers, beyond the normal assessment limitation period for a tax year, in respect of a disposition of real estate property by the taxpayer, in cases where the disposition is not reported in the taxpayer’s tax return for the year in which the disposition occurs.
There are other proposed changes related to principal residence exemptions of personal trusts which are not covered by this article. Affected taxpayers should consult their tax advisors and adjust course accordingly.
- Technical Backgrounder: Housing Insurance Rules and Income Tax Proposals: http://www.fin.gc.ca/n16/data/16-117_2-eng.asp
- Reporting the sale of your principal residence for individuals (other than trusts): http://www.cra-arc.gc.ca/gncy/bdgt/2016/qa11-eng.html
- Income Tax Folio, S1-F3-C2, Principal Residence: http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s1/f3/s1-f3-c2-eng.html
All content provided in this article is for informational purposes only and is not meant to be legal advice. Please consult your legal counsel or make an appointment to speak with us for further information.