The implementation of various amendments to the Income Tax Act (Canada)1 on December 14, 2017, saw a marked tightening of the mechanisms that allow a taxpayer to qualify for, and make use of, the principal residence exemption ( "PRE "). The PRE provides an exemption from income tax on a taxpayer's capital gain on the sale of their principal residence.2 While Canada remains a country where the sale of one's principal residence is (generally) exempt from capital gains tax, the ability to apply the PRE has become much less intuitive.
The aim of this paper is to provide a short summary of some of the road blocks a taxpayer may encounter, and some potential options to negotiate them.
General Understanding of the PRE rules since 2017
In order to be eligible for the PRE, there are several requirements that must be met; these requirements are in respect of both the property being disposed of and the taxpayer claiming the benefit. In no particular order, the following should be considered by any taxpayer wanting to claim the PRE:
- The property must be a "principal residence" as defined in the ITA. The definition includes, among other types of properties: houses (including the adjacent land, up to half a hectare), vacation homes, condominiums, and a share in a co-operative housing corporation;
- As a general rule, only one residence can be claimed by the family unit at a time.3 For the purposes of the PRE, the "family unit" includes the taxpayer, the taxpayer's spouse, and any un- married children under 18;
- The property must be ordinarily inhabited by an individual, their spouse or former spouse, or a child;4
- The property must be a "capital property ". Practically, this means that if the property was "flipped " a short time after the purchase, it may not qualify for the PRE;
- A change in Canadian residency status can affect the ability to claim the PRE; and
- Restrictions can apply to any property that was rented out for a part of the ownership time.5
The PRE eligibility is considered on a year-to-year basis for each year of ownership. This is reflected in the formula used to calculate PRE, as set out in paragraph 40(2)(b):6
|1+ number of years
the house was used and designated
as a principle residence
|X||Capital gain otherwise calculated|
|Number of years of
PRE and Non-Resident Individuals
The PRE can be claimed only by an individual who has been a resident in Canada throughout the year(s) that the exemption is being claimed. For a resident, the "plus one" in the above-noted formula corrects for the fact that (usually) an individual will sell one property and purchase a new one in the same year. However, the same leniency is not granted to non-residents. Indeed, with the recent amendment to s. 40(2)(b), there is a removal of the "plus one" in the formula if the person disposing of the property is a non-resident after December 31, 2016. Previously, a person who was a non-resident throughout the entire ownership of the property could have a portion (or even all) of the gain on disposition exempt from tax.
Individuals who are selling a property and who are thinking of emigrating would be prudent to consider their timing so as to maximize the amount of years the PRE is available to them.
When a US Citizen is Involved
Unlike Canada, the United States taxes its citizens (whether residing in the US or not) on their worldwide income. This income includes capital gains on the sale of their principal residence. A Canadian resident who maintains their US citizenship may face taxes in the US on the sale of their principal residence. Indeed, the Internal Revenue Service (IRS) permits only a partial exclusion of the capital gains on the sale of the principal residence: USD$250,000 if the taxpayer files as a single, and USD$500,000 if for a US citizen married couple who file jointly. Any excess amount will be taxed at a rate up to 24%.7
While the exclusion amounts may seem generous, especially with the dramatic rise in real estate prices in cities such as Toronto, Montreal, and Vancouver, this may result in Canadians residents who maintain their US citizenship owing US taxes unexpectedly come filing season (while having no Canadian tax liability in respect of the sale of this home).
There are some ways for US citizens living in Canada to mitigate their potential tax exposure with the sale of their principal residence. If the US citizen is married to a Canadian citizen, the easiest solution is to simply put the property in the name of the non-US citizen from the outset. This solution is ideal for both spouses. On the one hand, the couple is able to avoid US tax upon the sale of the property, as the property in question is strictly the Canadian spouse's property. On the other hand, should the marriage dissolve (either through a breakdown or a death), the US citizen would also be protected: given that they are married, they are afforded statutory property rights by the Family Act,8 meaning that should the marriage dissolve, the US citizen would still be entitled to their portion of the matrimonial home. Evidently, this requires some thoughtfulness at the time of purchase, which, depending on the status of the relationship at the time of purchase, may not always be possible.
There are other options available, such as the gradual gifting of the interest in the property from the US citizen to the non-US citizen within the US gift tax limits; any such planning should be done with US counsel 's tax advice and are beyond the scope of this overview.
1. RSC 1985 (5th Supp.), as amended (the "ITA"). For the purposes of this article, all references to a statute refer to the ITA unless otherwise specified.
2. ITA, section 54 and subsection 40(2).
3. The determination over which property to classify as the "princi- pal residence" may be challenging when the taxpayer owns both a home and a cottage. Samantha Prasad's article "Cottage Life: Selling your Cottage", 2017 The Tax Letter 35:7, provides a more in-depth look at how a taxpayer may make this determination.
4. The term "ordinarily inhabited" is not defined in the ITA, it is considered a question of fact. For example, the Canada Reve- nue Agency (CRA) describes in its Income Tax Folio S1-F3-C2: Principal Residence that a person who disposes of a property in the same year they acquired it will still be "ordinarily inhabiting it," while a person who purchases a property and keeps it for a longer period of time, but uses it as rental income, will not necessarily fit the criteria. It should be noted that an election under the ITA s.45(2) can be made if a property does not meet the "ordinarily inhabited" test in certain circumstances.
5. The rental of the home does not need to be restricted to the entire home; it can apply to part of the home as well. This provides an interesting aspect of the PRE to consider with the rise of households using letting services such as Airbnb to rent out a room or even their entire households for weekends in order to gain additional income.
6. The visualization of this formula is taken from Samantha Prasad and Ryan Chua "Changes to the Principal Residence Exemption: Home Sweet Home? 2017, Minden Gross Newsletter 1-7.
7. Matthew Getzler "Buyer Beware: The Sale of your Principal Residence May Not be Tax-Free After All" 2016, Minden Gross Newsletter 11 - 3.
8. It should be noted that common-law partners have different statutory rights depending on the province or territory in which they reside. In particular, only British Columbia, Saskatchewan, Northwest Territories, and Nunavut expressly provide that common-law and married couples share in property rights; all other provinces do not provide this protection for common-law couples.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.