My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, October 24, 2016

The New Principal Residence Reporting Requirements – Large Implications for the Average Canadian

On October 3, 2016, the Government announced administrative changes to the reporting requirements for the sale of a principal residence (“PR”) and the designation of the principal residence exemption (“PRE”), which provides for the tax-free sale of your home. The changes were premised on closing a tax loophole that allowed non-residents to buy homes and later claim a tax exemption on the sale by using family members or trusts. While I think the changes in reporting requirements were made in part to close this loophole, a skeptical person may think the government used the “foreign-buyer loophole” issue, to remedy lax reporting requirements for the sale of a PR by all Canadians.

In fact, I suggest the Government will get significantly more revenue from resident Canadians who have been misreporting the sale of their PR, than they will from foreign buyers. I see three (there are more than three, but these are the most obvious) potential areas the new rules will catch the average Canadian:
  1. Misunderstanding of the rules where you own both a home and a cottage 
  2. Divorce
  3. Flipping of houses

The New Reporting Requirements


Starting with the 2016 tax year, the new rules will require you to report the sale of your PR on Schedule 3 - Capital Gains or Losses, of your personal tax return. You will now be required to designate the property as your PR on Schedule 3. Previously, the administrative position of the Canada Revenue Agency (“CRA”) was that you were not required to report the sale of your PR if the property was your PR for every year you owned it.

If you do not designate the property as your PR for all the years you owned the property (such as where you had sold your cottage in a prior year and claimed the PRE for certain years), you are required to also file Form T2091.

I would not be surprised, if in the future, the CRA has follow-up information requests on PR sales, requesting the history of any prior PR sale that was not reportable under the old system to ensure there has been no duplication of the PRE.

History and Rules


Prior to 1982, a taxpayer and their spouse could each designate their own PR and each could claim their own PRE. Therefore, where a family owned a cottage and a family home, each spouse could potentially claim their own PRE, one on the cottage and one on the family home, and accordingly the sale or gifting of both properties would be tax-free.

However, for any year after 1981, a family unit (generally considered to be the taxpayer, his or his spouse or common-law partner and unmarried minor children) can only designate one property between them for purposes of the PRE. Although the designation of a property as a PR is a yearly designation, it is only made when there is an actual disposition of a home. For example, if you owned and lived in both a cottage and a house between 2001 and 2016 and sold them both in 2016, you could choose to designate your cottage as your PR for 2001 to 2003 and your house from 2004 to 2016 or any other permutation +1 (see formula calculation and discussion of the +1 rule below).

In order to decide which property to designate for which years after 1981, you must determine whether there is a larger gain per year on your cottage or your home in the city. Once that determination is made, in most cases it makes sense to designate the property with the larger gain per year as your personal residence for purposes of the PRE.

As if the above is not complex enough, anyone selling a cottage and claiming the PRE must also consider the following adjusted cost base adjustments:

1. If your cottage was purchased prior to 1972, you will need to know the fair market value (“FMV”) on December 31, 1971; the FMV of your cottage on this date became your cost base when the CRA brought in capital gains taxation.

2. In 1994 the CRA eliminated the $100,000 capital gains exemption; however, they allowed taxpayers to elect to bump the ACB of properties such as real estate to their FMV to a maximum of $100,000 (subject to some restrictions not worth discussing here). Many Canadians took advantage of this election and increased the ACB of their cottages.

3. Many people have inherited cottages. When someone passes away, they are deemed to dispose of their capital property at the FMV on the date of their death (unless the property is transferred to their spouse). The person inheriting the property assumes the deceased's FMV on their death, as their ACB.

4. Most people have made various capital improvements to their cottages over the years. For income tax purposes, these improvements are added to the ACB you have determined above. Examples of capital improvements would be the addition of a deck, a dock, a new roof or new windows that were better than the original roof or windows, new well or pump. General repairs are not capital improvements and you cannot value your own work if you are the handyman type.

The Actual PRE Formula


The actual calculation to determine your principal residence exemption is equal to:

The capital gain on the sale of your home multiplied by:

The number of years you have lived in your home plus 1 
The number of years you have owned the property

The one year bonus is meant to ensure you are not penalized when you move from one house to another in the same year.

The Three Potential Issues for Resident Canadians


Misunderstanding of the Rules Where You Own a Home and a Cottage


As noted above, the PRE rules are extremely complex and the formula is often misunderstood. Many Canadians have simply understood or pretended to understand that any sale of a home or a cottage was tax-free if it was used by you and your family. Since there were no reporting required on your tax return until these changes, the CRA could not track whether you were properly reporting the sale of your PR. The new reporting will now allow the CRA to track overlapping ownership periods (i.e. you bought your home in 1990 and your cottage in 2000 and sold your cottage in 2016 and claim the PRE for 16 years. The CRA will now have a record that you have used 16 years of your PRE and you cannot claim those 16 years when you sell your home). This required filing will also force you to consider any prior PRE claims that may have occurred during the 16 years above (say for example you had sold the home you purchased in 1990 in 2010 and purchased a new home that same year. Under this circumstance you could not claim 16 years PRE on your cottage).

As noted above, I would expect at some point in the future, to see information requests and audits of reported gains by the CRA, specifically asking about prior PRE claims to ensure there was no overlapping of of PRE claims.

Divorce


In June of this year, I wrote a post on the income tax implications of divorce where you owned a home and a cottage and the various misunderstandings of how to claim the PRE exemption that arise on divorce. You can read this post if it is of interest to you, but some of the key points I made were as follows:

1. A couple can only claim one PRE during the marriage (other than when a spouse who was throughout the year living apart from and was separated under a judicial or written separation agreement). This one PRE rule per couple is clearly noted in this interesting case, Balanko v The Queen.

2. It is vital that the right to the PRE or the allocation of the PRE must be accounted for in any marriage settlement, for both purposes of the actual claim, and the related income tax one of the spouses may incur. If the use of the exemption is not addressed in the separation agreement, it is then a first-come, first-served claim.

I would suggest that many divorced couples have inadvertently double claimed the PRE.

Flipping of Houses & Condominiums


The CRA has been going after “house and condominium flippers” for the last few years. However, since there has been no reporting requirement for the sale of a PRE, if a “flipper” felt or considered the sale to be of their PR, the CRA was constrained in tracking these house flips. While prior sales may be hard to audit, the new rules force someone flipping a house to report the gain as a PRE and I am sure any sale of homes and condominiums that are of short duration will be subject to follow-up or audit.

Assessment and Penalties


For the sale of a PR in 2016 or later years, the CRA will only allow the PRE if you report the sale and designation on your tax return. If you fail to report the sale, you will have to ask the CRA to amend your return. Under the proposed changes, the CRA will be able to accept a late designation but a penalty may apply, equal to the lesser of $8,000 and $100 for each month you are late from the original required filing. This is a potentially fairly large penalty for non-compliance. The period of re-assessment will also be extended where a disposition has not been reported.

Wow, what some may have seen as a fairly innocuous change to catch non-residents, will certainly have substantial implications on resident Canadians going forward and in some cases, on previous non-filings related to PRE claims.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

30 comments:

  1. Thanks for the post, is there any reporting requirement where a family lives in a new place but rent out the old place they lived aso PR. Does the deemed disposition from change of use requires reporting if the change in use was prior to 2016

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    Replies
    1. Hi Garden:

      These reporting requirements are for 2016 onward. If you had a change in use in 2015 it is important that you have documentation supporting the date the use changed and a valuation supporting the value at the change in use date

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    2. Thanks very much for clarification. Your interpretation and explanation on various tax topics are always useful

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  2. Since you can only claim one residence as PR during a year, if you sell a house and buy another in the same year are you somehow unable to claim the PR against both houses for that year?

    I.e. Buy in 2000, sell June 1, 2015, buy June 1
    2015, sell dec 31 2010

    Would you have 5 years of PR for each property? I would hope commensense prevails.

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    Replies
    1. Hi David

      As noted above the CRA allows a +1 year in the formula to prevent your situation from occurring

      Delete
    2. Hi Mark,

      Similar mathematical question on PRE formula for my scenario:

      Property #1: Bought and moved in January 2000, moved out in July 2016 to Property #2, couldn't sell #1 until July 2017
      Property #2: Bought and moved in July 2016

      It's now 2017 tax year time: is PRE 100% on Property #1 because (16 years lived in + 1) / 17 years owned?

      And if I sold Property #2 in July 2020 (having lived in there the whole time), PRE is also 100% for it?

      Thank you.

      Delete
    3. Hi Anon

      I don't provide personal tax planning on this blog. That being said, you seem to have a grasp on the PRE, but keep in mind for property two you will have lost the 2016 designation for use on prop 2, so if you have a similar scenario in 2020 where the house is not sold, you may end up having one year taxable.

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  3. I am on the property title for my parents' house although I no longer live there. I am going to get the title document changed to remove myself from the deed in 2016. Is that considered a sale of my share in the property even though I am not going to receive any compensation from them for it? Do I have to declare capital gain/PRE on it?

    ReplyDelete
    Replies
    1. Hi Anon

      I do not provide personal tax planning advice on this blog. I will say that the change in title could be problematic and you should get a tax consultation to understand the consequences of doing so.

      Delete
  4. We exclusively use a small proportion of our principal residence to conduct a home-based business. Will this percentage be excluded from our principal residence exemption on sale now that the sale (and exemption) are being reported?

    ReplyDelete
    Replies
    1. Hi Unknown

      See 2.50 of the Folio to give you some direction.


      http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s1/f3/s1-f3-c2-eng.html

      Delete
  5. Mark, thanks for this great article. You wrote a thorough and detailed explanation of how the new rules affect ordinary Canadian homeowners and taxpayers. Coincidentally, we sold a property this year before the rules were announced but since they apply to the full year, we'll feel the impact. Saving your article for discussion with our tax accountant. Thanks again!

    ReplyDelete
  6. I work in Saskatchewan during the week days and bought a house recently there instead of renting. My wife and kids still live in Alberta at a house we've lived for past 5 years and I go back during the weekends to see my family. Can each of us to claim PR on each property under the new change?

    ReplyDelete
    Replies
    1. Hi Anon

      As noted above, each family unit can only claim one PRE, thus the answer is no.

      Delete
    2. Thanks for your reply. The new rules really changes everything.

      Delete
  7. Mark
    A person owns both a house and a cabin for 20 years and then sells the house and claims it as their principal residence, paying no capital gains. They then use the cabin for the next five years as their principal residence and during that time the value of the cabin increases at a much greater rate than it did in the first 20 years. Lets say in the first 20 years it increased $100k and then again increased in value in the next 5 years by $100k.
    Using the CRA's formula, if the person was to sell the cabin, the capital gain would be around $152k when in fact it should only be $100k.
    Do you know if the CRA makes any allowances for a situation like this?

    ReplyDelete
    Replies
    1. Hi Anon

      I understand your question and why you would not like how the formula works in your situation, but it could go the other way also. The CRA makes no allowance, your gain is however reduced by the years you designate the cabin as your PR.

      Delete
  8. Hello Mark
    It has been my experience that, prior to the above changes, that with simple estates where the principle residence was the primary asset, that the CRA was not overly concerned about any changes in value of princicple residence between the time the individual passed away and when the house was eventually sold(if sold in a timely manner). With the above changes do you see this being a bigger issue going forward? Should a tax professional be counselling executors to get an assessment completed for all principal residences at the time of death to determine Fair Market Value?(I assume that I know the answer already). Thanks. Thanks for the blog, it makes for insightful reading.

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    Replies
    1. Hi Brandon

      I think your experience has been similar to mine. You are correct, you do know the answer. I think the CRA will be looking a lot closer at this issue, so the prudent advice is to tell them to get a valuation at death, however, depending upon the circumstances and timing, that may not be the most practical advice, but let the client make that decision, not you.

      Delete
  9. Hello Mark,

    Having lived for two years in our condo we are selling it this year and getting into possession of a new one which was bought as a pre-sale and will be completed in the same month I am selling my current condo. However, as we realized it will be not big enough for our family we decided to sell it as well and buy a townhouse instead in different area. All transactions will happen in the same year and my second condo will be our principal residence for 2-3 months only until it is sold. Will the capital gain from the sale of this condo subject to capital gain tax since we will have owned it less than 1 year?

    ReplyDelete
    Replies
    1. Hi Dream Job

      Sorry, I do not answer specific personal tax planning questions on this blog, especially relating to multiple residences as the issue is complex and often requires detailed calculations. I would suggest you engage an accountant to assist you in this matter if u do not already have one.

      Delete
    2. Hello Mark,
      Thanks for your response. I will definitely do that. Meanwhile,making the question simpler, how long do I need to live in my house as a principal residence to qualify for PRE ? Appreciate your response.

      Thanks

      Delete
  10. Hello Mark,

    How long shall I live in my principal residence to qualify for PRE ? Can it be less than 1 year ? The tax rule says that property qualifies as principal residence when "You, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year". What is some time here ? Thanks!

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    Replies
    1. Anytime in the year can be one day, but other factors may come into play whether the property qualifies for the PRE. That is why you have to discuss your situation with an accountant who is aware of all the specific facts and can guide you

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    2. Thanks! I was of impression that if all of the four conditions for a property to qualify as my principal residence are met CRA cannot challenge it. Anyway, thanks a lot! Your blog is a tremendous help!

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    3. Not necessarily, many people have bought and sold houses/residences that meet the criteria and claimed the PRE and the CRA has reassessed

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    4. Can you defend you case in the court? It sounds like people are left defenseless against CRA.

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    5. its all facts. If you have good facts you can win, bad facts maybe not. Most people do not get assessed or go to court, just engage an accountant to review your situation, your situation may be clear cut

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