Why read this?
- › Your client sold her property
- › Your client transferred ownership of her principal residence to a relative
What to do
Your client can claim only one property at a time as a principal residence, unless she’s a Canadian resident selling one property and moving into another in the same tax year (permitted under the “plus one” rule). A family unit (the taxpayer, along with her spouse and any unmarried minor children) is entitled to one principal residence exemption (PRE) per year.
› Check if the property is eligible (see “PRE criteria”).
› Determine in what years the property was your client’s principal residence. Capital gains from years when the property wasn’t her principal residence will be taxed. CRA’s formula for determining tax for Canadian residents is:*
([1** + number of years designated]/number of years owned) x gain = exemption amount
**Foreign residents don’t get the plus one.
For example, if a person owns a home for 15 years, but it was a principal residence for only 13 of those years, and they had a $100 capital gain on the residence, this is the amount that could be sheltered by the PRE:
([1 + 13]/15) x $100 = (14/15) x $100 = $93.33
Warning: Any income-earning portion of a residence isn’t tax-exempt. Calculate the percentage of living space using square metres or the number of rooms, says CRA. The split must be reasonable. Multiply that percentage by the capital gain to determine the PRE.
Claim the PRE
a. To designate the property as a principal residence for all years your client owned the property, select Box 1 on page 2 of Schedule 3 of the T1 Income Tax and Benefit Return.
b. To designate the property as a principal residence for some but not all years your client owned the property, select Box 2 (or 3 for more than one property) on page 2 of Schedule 3.
Determine the capital gain
If there’s a capital gain to report (i.e., the home was not your client’s principal residence the whole time she owned it), your client must submit the appropriate form in the year she sells, or is deemed to have disposed of, all or part of her principal residence, or grants someone an option to buy all or part of her principal residence.
a. If your client previously reported a capital gain on the property at the end of February 22, 1994, she fills out Form T2091(IND)-WS Principal Residence Worksheet, and then Form T2091(IND) Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust), to calculate the PRE and the remaining capital gain.
b. If she hasn’t previously reported a capital gain on the property, she completes Form T2091(IND).
Finalize the tax forms
› Enter the amount from Line 66 of Form T2091(IND)-WS onto Line 55 of Form T2091(IND). Attach a copy of the worksheet.
› Enter the total from Line 56 of Form T2091(IND) on Line 158 of Schedule 3.
› Enter the result of Line 199 of Schedule 3 on Line 127 of your client’s return. Attach a copy of Schedule 3 to the return.
Warning: Owners and immediate family members cannot claim different principal residences unless they’re separated or living apart.
Your client transferred ownership of her home to her adult child to avoid probate, forfeiting the PRE. Upon sale, her child will pay capital gains tax if the home’s value has increased.
Paul McVean, president of Astute Strategies in Thornhill, Ont., strongly advises against such a transfer, particularly during “times of rising real estate prices where the tax savings of the PRE might be far in excess of the probate savings.” An alter-ego trust could have been used instead, provided it had followed strict rules (see Advisor.ca/PREtrust).
Since the damage is already done, “The child could transfer the property back to the parent without a tax cost if it has not increased in value,” says McVean. If it has, that “would trigger any capital gains that had accrued since the initial transfer.”
Warning: If your client forgets to designate a principal residence in the year of sale, she must ask CRA to amend her income tax and benefit return for that year. CRA may accept a late designation, but a penalty of up to $8,000 could apply.
To mitigate any gains, look at the following:
- If the child ordinarily occupied the property, he could claim the PRE on the home—but he couldn’t claim it on any other residence for that period.
- Sale costs, such as real estate commissions and legal fees, can reduce the capital gain.
- The child could sell other non-registered capital property (e.g., rental properties, stocks) to create a capital loss and partially or fully offset the capital gain on the home sale. (Beware the superficial loss rules if he reacquires the property later.)
- Property must be eligible as per CRA.
- The person claiming the exemption must own or co-own the property in the tax year.
- The home must be ordinarily inhabited by the owner, her current or former spouse or common-law partner, or her child. (CRA does not define “ordinarily inhabited,” saying it’s a question of fact.)
A property occupied part of the year, like a cottage, may be considered a primary residence unless its main purpose is to “gain or produce income,” says CRA.
Fortunately, “a person receiving only incidental rental income from a housing unit is not considered to own the property mainly for the purpose of gaining or producing income.”
Sources: Paul McVean, tax partner and president of Astute Strategies in Thornhill, Ont.; CRA
*A previous version of this story misstated the formula for calculating the PRE. Return to the corrected sentence.