Your principal residence is tax exempt

We all love our homes. They are after all, a reflection of our personalities and tastes and where we feel most comfortable. In Canada, the expression “A Man’s/Woman’s Home is his/her Castle” has never been truer, as the cost of a basic home has seemingly become equivalent to the cost of a castle twenty-five years ago.

The blood, sweat and tears expended and the pure dollars spent purchasing, repairing and renovating our homes generally make our homes our single biggest purchase/investment. Thus, we cherish the fact that the gain on the sale of our home is tax-free (subject to the discussion below). Many Canadians rely on the equity accrued in their homes to partially or fully fund their retirements.

The mechanism for sheltering the capital gain realized on the sale of a home from personal tax is the “principal residence exemption” (“PRE”). The PRE is a formula provided in the Income Tax Act that if fully understood, may be used to gain a tax advantage in certain situations.

The actual calculation to determine your principal residence exemption is equal to:

The capital gain on the sale of your home

multiplied by

The number of years you have lived in your home (i.e. designated the home as your principal residence) plus 1

divided by

The number of years you have owned the property

If you have lived in your house from the time you purchased it to the date your sell it, the numerator will always be greater than the denominator by one year. If you have moved from one principal residence to another principal residence, the extra one year will be like a sixth toe, essentially useless.

But what if the housing market is not co-operating and subsequent to you purchasing and moving into your new house you cannot find a buyer for your old home? You may be forced to rent out your old home for a few years. Technically, under Canadian income tax rules the change from a principal residence to a rental property will trigger a deemed disposition of your house at its current fair market value (typically the appraised value). If you have always lived in your original house, the deemed disposition will not create an income tax liability due to the application of the PRE. However, you will be deemed to have reacquired your old home at a cost equal to the appraised value at the date you changed the use and any future increase or decrease in value will be a capital gain/loss when that property is sold.

A taxpayer who finds him or herself in the situation described above may be permitted to file an election known as a “45(2) election”. If filed, this election would  prevent an immediate deemed disposition of your original home and allows you to treat the original house as your principal residence for up to four years as long as you don’t claim depreciation and you are resident in Canada, even though the property is being rented and you are not living in the property.

So, if you moved out and rented the original house for five years, that dangling one year in the formula above would prove useful, as you could claim the original house as your principal residence for the four years per the 45(2) election and the one extra year per the formula. Any gains realized on the sale of your original home during those years would be sheltered from tax.

The downside to utilizing the 45(2) election is that for the four years the original house is claimed as your principal residence, your new house cannot also be claimed as a principal residence, causing your new home to be partially taxable when eventually sold.

It should be noted that if you file a 45(2) election and rent the original house for more than four years, the election would continue to defer the deemed disposition of the property, however, when the house is eventually sold, a portion of the gain on the house would be taxable in the year you actually sold your house.

Under certain conditions where a move is for employment reasons and the new home is at least 40km from your original residence and you subsequently move back into the home the 45(2) election will not be required and your old home will continue to qualify as a principal residence.

You can only have one principal residence per family, so where you own a cottage and a house, you may have to play with the numbers to see which property has the largest gain per year. You would then designate as your PR the property which has the larger gain per year for the required number of years to fully offset the gain on that property. However, you would still have that dangling one year to use on the other property.

The principal residence exemption is typically an after-thought for most Canadians, buy a house, live in it, sell it and claim the exemption. However, as noted above, it sometimes can get very complicated to determine how to effectively use the exemption. In certain circumstances, care must taken to ensure that the PRE is fully maximized.

Where a reader owns more than one home for any of the reasons noted above, they are strongly encouraged to seek professional advice in dealing with this issue as there are numerous pitfalls and issues as noted above and the advice above in general in nature.

Written by Mark Goodfield

Mark Goodfield writes the blog The Blunt Bean Counter. He is taxation and managing partner of Cunningham LLP Chartered Accountants in Toronto.

Filed Under: Tax

21 Responses to Your principal residence is tax exempt

  1. Hi Jim:

    Love the site and really enjoyed your article on IPPs within an incorporated company.

    My question is about the principal residence. My wife and i have a condo (which was hers before we got married). Is there a way to set a date (ie – when she officially moved into my home and we started renting her condo) and establish her tax free capital gain? Essentially – only paying tax on further appreciation beyond that milestone date?

    Thanks
    Glenn

  2. Hi Glenn:

    Since I wrote the guest blog, Jim has asked me to answer you.

    When your wife changed her property from a principal residence to a rental property she triggered a deemed disposition of her condo at its current fair market value (typically the appraised value). The date is a question of fact, but it would probably be the date she started renting the property rather than the date she moved into your home. It is somewhat a moot point if those dates are close and in the same year. Assuming she always lived in the condo and you were not living common-law(if so, you can only designate one principal residence for those years)the deemed disposition “establishes” her tax free capital gain (principal residence exemption), since she did not elect otherwise under section 45(2).

    The value at the time she moved out and rented the condo also establishes the new cost of the condo going forward. Thus, in your words, she will only pay tax on further appreciation from the milestone date. You should obtain an appraisal of the condo at the date she started renting it, as that forms the new cost.

  3. What happens if a parent and multiple adult children are on title for a personal residence, but only the parent is living in the house… When the house is sold, do the children have to pay capital gains tax?
    Thanks, J. Gonzalez

  4. Hello

    I have a question re my mother’s condo. She purchased this condo quite a while ago (>15 years). For the last few years she has been living in a senior’s facility and the condo has been sitting empty. It has NOT been occupied at any time since show moved out, and thus has NOT been generating any income. My question is how are these last few years treated? I.e., for tax purposes is the condo considered to be her principle residence for the last few years or not?

    Thanks

  5. Hello,
    I am interested in buying a little home in Texas. If I am a renter in Canada, would I be able to claim my Canadian rental home as my principal residence, while actually owning a place in the States? I’d be splitting my time between the places.
    Thanks!

  6. My parents bought a house 15 years ago. They lived there for about 2 years. Then, my dad started his job as a property manager in an rental apartment. He is required to live in the apartment (with discount on rent). My dad and my mom moved to the apartment due to the nature of his job. Their house was rented out for about 13 years. (Rental incomes were declared in their tax returns). My dad is going to retire next year. My parents are expected to move back to their house. I am just wondering if they are qualified for the Principal Residence Exemption. Thank you.

  7. Hello,
    We moved from our principal residence at Toronto in 2005 to Ottawa and lived in rental home till 2011 and claimed our principal residence as a rental property. in 2011 we bought a home in ottawa as principal residence.
    But again now we sold our ottawa home and wants to move back to toronto in our rental property.
    My question is how it will effect my taxation and how long I should live in my rental property to claim as my principal residence again. I am planning to live in my rental property for atleast one year before we sell and buy another home in Toronto

  8. Hi Jim,
    Maybe you can help – nobody else has been able to assess my situation. Bought a house in Toronto in Nov2004 that came with a basement rental suite – I lived upstairs. Moved to Calgary in Dec2006 for a job, so rented out the upstairs instead and kept the basement suite for myself since I am in Toronto to visit my kids (once or twice a month). I have not claimed any other property as my PR. Could I claim the Toronto house as my PR? The only reason I have kept the house is to have a place to visit my kids – so is the income ancillary? (no structure changes and no CCA). I did not file a 45(2). Even if not a PR under the ‘retains its nature’ clauses for partial changes in use, does the moving clause help me? Or would I have to move back into the house? If you could help me that would be great – no one else has been able to!

  9. My husband and I own a Condo which is registered in his name.We also own a summer home which is registered in both of our names.Since we spend several months annually in our summer home we would like to make it my principal residence.Is there any reason ,in terms of capital gains,why we cannot simply transfer the title or just have it registered in one name.Thank you for your response.

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  11. Most agents were, on average, between 40-45 hours per week.
    The State government has also done heavy capital investments in the major automobiles, pharmaceuticals and textile corporations
    of the city. People who own condominium units may modify the design of their units, whereas
    apartment occupants are not allowed to.

  12. When I initially commented I clicked the “Notify me when new comments are added” checkbox and now each time a comment is added I get four emails with the same comment.
    Is there any way you can remove people from that service? Cheers!

  13. Hi, I own a 3 floor building in Toronto. I use only one floor remaining two are rented to 2 families. Now I want to know how this principle residence tax exempt will help me. I am living in this property for last 15 years, the two floors are on rent from last 4 years.

  14. Hi,

    I bought a house 5 years ago and tried to sell it 2 years ago before I got married. I ended up having to rent it out and now potentially have a buyer for the house. Is filing for the 45(2)election my best route as I never intended it to be a income property and had no choice but to rent it out? And who is best to speak with on advice for this, a lawyer? Thanks!

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