Principal residence exemption

Changes to the principal residence exemption reporting requirements

In October 2016, the Canada Revenue Agency (“CRA”) announced a change to their administrative policy relating to the principal residence exemption.

History

In the past as an administrative concession, the CRA did not require an individual to report the disposition of a property designated as their principal residence. The reason for this administrative concession, was that ordinarily on the sale of the principal residence there would be no tax to report, as the capital gain resulting from the disposition would be exempt from tax.

Issue

If an individual has both a home and a cottage, and sells one of them at a profit, the individual must decide as to whether to designate the property disposed of as their principal residence for some or all of the years it was owned. If the individual sells the cottage that they have owned for 10 years, they can designate the cottage as their principal residence for the entire 10 years in order to eliminate capital gains tax, as long as they have not designated any other property as their principal residence during that time. If subsequently the individual sells their home for a profit they will likely pay tax, as they cannot designate the home as their principal residence for the 10 years where the cottage was designated. However, if the individual is unaware of the principal residence exemption rules, they may inadvertently misreport the sale of the home in the year of disposition.

New rules

To improve administration of the tax system, the CRA is changing their administrative policy regarding reporting the principal residence exemption. Effective January 1, 2016, the sale of a property designated to be a principal residence must be reported in Schedule 3 of the Income Tax and Benefit Return in the year the property was sold. The new rules apply to deemed dispositions. One example of a deemed disposition is where a property is changed from personal use to rental property.

Implications

Any principal residence designations must be reported in the tax return for the year the property was sold. Failure to report may preclude the taxpayer from claiming the principal residence exemption. The CRA may accept a late designation, however, a penalty of up to $8,000 may be imposed. Furthermore, individuals should closely monitor all capital improvements made to their properties. The improvements may increase the cost of the property and could save tax later, in cases when the principal residence exemption is not fully available.


Your trusted accountant provides tax advice for reporting and calculating the gain on the disposition of the principal residence.