Capital Gains on Primary Residence and Principal Residence Exemption

To read more chapters, click below:

Chapter 1: All that you want to know about Capital Gains in Canada

Chapter 2: Effect of capital gains on property and investments

Chapter 3: Realized vs. unrealized capital gains

Do you anticipate incurring capital gains upon the sale of your home? It's contingent on whether your property has consistently served as your principal residence throughout your ownership and whether any part of it has been used for income generation.

If your home qualifies as your principal residence both during your ownership and at the time of sale, you are exempt from paying any capital gains tax.

What is a principal residence?

In Canada, a principal residence is a property that is designated as the main place of residence where an individual, their spouse or common-law partner, or their children live. It is the primary dwelling where a person considers their home.

Here are some key characteristics of a principal residence in Canada –

• Ownership: The property must be owned, in part or in full, by the individual claiming it as their principal residence.
• Use: The property must be used primarily as a place of residence. It should serve as the individual's primary home, and they must reside in it for some or all of the year.
• Designation: The property owner must designate it as their principal residence on their income tax return for the years they are eligible for the principal residence exemption.
• Exemption: The principal residence is eligible for the principal residence exemption, which can reduce or eliminate the capital gains tax that would otherwise be payable upon the sale of the property. This exemption can be valuable, as it helps homeowners avoid or reduce the tax liability associated with the sale of their primary residence.

Please note that while individuals can designate a property as their principal residence for each year they own it, they can only designate one property per family unit as their principal residence for each tax year. Additionally, certain conditions and rules may apply, especially if the property is used for income-generating purposes or if the property is not the individual's primary place of residence for the entire year.

The rules and regulations related to principal residences and the principal residence exemption can be complex, and they may change over time. Therefore, individuals are encouraged to consult with tax professionals or the Canada Revenue Agency (CRA) for specific guidance and to stay up-to-date with current tax laws and regulations.

How does the CRA determine a principal residence?

Determining what qualifies as a principal residence can be a complex matter with several grey areas. The Canada Revenue Agency (CRA) does not prescribe a specific number of days you must spend in a property for it to be considered a principal residence in any given year.

Keep in mind that you don't necessarily have to reside in the property on a full-time basis to claim it as your principal residence. However, taxpayers may be required to provide evidence that they physically occupied the property in the years they designate it as their principal residence, especially if they plan to claim the principal residence tax exemption upon selling the property. Having verifying evidence can be crucial in case the CRA decides to audit your claim.

When the CRA investigates a claim for a principal residence exemption, they adopt a case-by-case approach, carefully examining all relevant facts and circumstances. Some of the aspects they take into account include –

• Utility Bills: Checking whether utility bills are addressed to your name, which can indicate your occupancy.
• Rental Period: Evaluating the number of days the property was rented out versus the number of days you spent living in it.
• Transaction History: Reviewing your real estate transaction history, including any prior sales or purchases of properties.
• Capital Gains: Analysing the amount of capital gains earned from the sale of the property.
• Rental Income: Assessing any rental income generated from the property.
• Income Sources: Examining your sources of income outside of real estate.

The CRA takes a comprehensive approach when investigating these claims and uses the information gathered to determine whether they will approve or deny your principal residence exemption.

Technically anyone could claim that a property they sold was their principal residence. This is precisely why the CRA scrutinizes these claims carefully. If the CRA suspects that a claim may be inaccurate, they may reach out to you to verify the details of your residency. Therefore, maintaining accurate records and documentation of your property's use and occupancy is essential to support your claim.

Principal residence tax exemption

The CRA mandates that all taxpayers must report capital gains from property sales on their annual tax returns. Nonetheless, an exception to this rule is granted by the CRA for properties meeting the criteria as a principal residence. If your home meets the qualifications for the principal residence tax exemption, you are not obligated to pay capital gains tax on the proceeds generated from the property's sale.

In recent years, the CRA has adopted a more rigorous approach to scrutinizing claims for the principal residence exemption. Therefore, it's crucial to have a clear understanding of how this tax exemption operates before you proceed with claiming it.

The CRA imposes capital gains taxes on individuals engaged in real estate investment activities aimed at profiting from property sales. This category encompasses various scenarios, including the following –

• House flippers, who purchase properties, renovate them, and subsequently sell them at a profit.
•  Individuals who acquire properties for rental purposes and later decide to sell them.

As of the current tax regulations in Canada, the capital gains tax rate stands at 50% of the realized capital gains.

For instance, suppose you invest in a property valued at $300,000 and then sell it for $350,000 the following year, resulting in capital gains of $50,000. With a 50% capital gains tax rate, you are only required to include $25,000 (equivalent to half of the $50,000 gain) in your taxable income for that specific year.

Keeping this in mind, the principal residence tax exemption has the potential to yield substantial tax savings that would otherwise be incurred when selling an investment property.

Frequently Asked Questions (FAQs)

1. Can I rent out my principal residence?

Contrary to what you might anticipate, it is possible to lease out your primary residence and still qualify for the principal residence exemption. However, this eligibility hinges on the number of days the property has been rented out during a specific year.

For instance, numerous homeowners choose to rent their residences through platforms like Airbnb while they are on vacation. In such situations, you may still be eligible for the principal residence exemption. However, if your property is primarily used as a long-term rental for tenants, you won't qualify for the principal residence exemption in that particular year.

2. Can I have principal residence outside of Canada?

You have the flexibility to designate a property in various countries as your principal residence. For instance, you may choose to designate a primary residence in Puerto Rico or another Caribbean nation. As long as you predominantly use the property for personal purposes rather than renting it out, it should qualify for the principal residence tax exemption.

3. How many principal residences can I have?

In Canada, you are generally allowed to have only one principal residence for tax purposes at a time for each tax year. The principal residence is typically the place where you and your family reside and consider your main place of residence.