Home Sweet Home

2017 BRINGS CHANGES TO THE PRINCIPAL RESIDENCE EXEMPTION

Canadian residents generally enjoy tax-free growth in the capital value of their principal residence. This tax measure, referred to as the principal residence exemption, provides tremendous value as it allows many Canadians to sell their home tax-free. It allows qualifying individuals to move between homes without the worry of a tax liability arising upon the sale of one home that would otherwise affect the cash available to purchase the next. For many Canadians, the value of their property represents a substantial proportion of their personal wealth. On October 3, 2016 Finance Minister Morneau announced new measures to address the housing market, and improve the fairness and integrity of the tax system as it relates to the principal residence exemption. The changes include new reporting requirements, modifications to the calculation of the tax-free amount for individuals based on a residency requirement, and an extension to the period in which a reassessment may occur.

NEW REPORTING REQUIREMENTS

While the rules require that a claim for the principal residence exemption be reported using form T2091 when a principal residence is sold in Canada, it has been the Canada Revenue Agency’s (CRA) long standing administrative position not to require reporting when there is no net gain. This means most Canadian’s have typically not filed any paperwork in respect of their claim for exemption on the sale of their principal residence. This administrative leniency has now ceased. All dispositions on or after January 1, 2016, for which the principal residence exemption is claimed, will have to be reported on schedule 3 of an individual’s personal income tax return along with the required filing of form T2091. Taxpayers who fail to report the disposition of their home will not be eligible to claim the principal residence exemption to shield the gain on the sale from taxation. A taxpayer can request an amendment of a prior tax return to report the disposition and make a claim for the principal residence exemption. However, the CRA has indicated that they may enforce late filing penalties in extreme situations. The penalty would be the lesser of $8,000 and $100 for each month between the original due date and the date the request for amendment is made. This updated reporting requires individuals to report a disposition and claim the exemption, but will not create additional taxes for most Canadians. What it will do, however, is highlight those individuals who frequently buy and sell their residences. In some of these situations, the CRA may assess the gain on such dispositions as profit from the business of trading homes. With more sales information, the CRA will be better positioned to ferret out higher risk profiles that could lead to more audits.

CALCULATION OF THE EXEMPTION AMOUNT

The gain realized on the disposition of a principal residence may be eligible for a reduction referred to as the exemption. This exemption amount prior to the October announcement was derived from the following formula: { ( 1 + A ) ÷ B } times the gain realized upon disposition Where, • A is the number of years the house was the principal residence and the owner was resident in Canada • B is the number of years of ownership A taxpayer’s ownership period begins in the year of purchase and ends in the year of disposition. The numbers used in the formula above are whole years with no decimal places. For example, if the ownership was from June 1990 to April 2015, the result would be 16 years of ownership. The “1” in the formula is used to allow individuals to buy and sell a home in the same year and is commonly referred to as the “one-plus rule.” Because only one home may be designated as a principal residence in any single year, the “1” ensures individuals do not incur taxation simply because of the sale and purchase in the same year.

The October 3, 2016 proposal is to eliminate the “1” in the formula above in respect of individuals who are nonresident in the year of purchase. This change is effective for all dispositions on or after October 3, 2016 regardless of when the house was purchased. The implementation of this change necessitates the collection of facts to prove residency in the year of purchase. Consider the example of Peter who purchased a home in Canada for $450,000 in 2010, but did not immigrate to Canada until 2011. Assume Peter sells this home in 2017 for $690,000. He will realize a gain of $240,000 and would report seven (A in the formula) as the number of years that the home was his principal residence and he was resident in Canada (2011 to 2017 inclusive). Peter’s years of ownership (B in the formula) would be reported as eight. Peter will be entitled to reduce his $240,000 capital gain by 7/8th of $240,000, which equals $210,000 [(A ÷ B x $240,000)], leaving him with a $30,000 capital gain to report on his 2017 income tax return. By removing the “1” from the formula because Peter was not resident in Canada in the year of purchase, Peter is exposed to additional personal taxes on the net $30,000 capital gain.

EXTENDED REASSESSMENT PERIOD

The October 3rd announcement also proposes to allow the CRA to reassess beyond the normal reassessment period, which is generally three years for individuals from the date of the initial notice of assessment. This means individual taxpayers who dispose of real or immovable property, but do not report the disposition, will be subject to reassessments that extend beyond the normal reassessment period. These changes to the principal residence exemption will affect every home owner in Canada. The impact for the majority of Canadian residents should be minimal – reporting a disposition when selling a home. However, there is a higher probability of catching those who may be misusing the principal residence exemption, and the new exemption formula will limit its availability to those years in which the owner is resident in Canada.

COMMENT Edition 300 - November / December 2016

The Institute for Advanced Financial Education

Authors:
James W. Kraft, CPA, CA, MTAX, TEP, CFP, FEA, CLU
Deborah Kraft, MTAX, LLM, TEP, CFP, CLU

Published by:
The Institute
390 Queens Quay West, Suite 209
Toronto, Ontario M5V 3A2
T: 416.444.5251 or 1.800.563.5822
F: 416.444.8031
www.iafe.ca • info@iafe.ca