Selling a home? How to know if you qualify for a capital gains exemption
When selling a home, Canadians may be exempted from paying capital gains tax on a residential property if it is determined to be their principal residence. A capital gains tax is normally applied to 50% of your profits made from selling an asset for a profit.
However, the CRA is a bit vague when defining one’s principal residence, and several factors could either help or prevent you from qualifying for the principal residence tax exemption.
Below, I’ll explain more about how the CRA determines principal residence and answer some questions about what types of properties may be eligible for the tax exemption.
THE PRINCIPAL RESIDENCE TAX EXEMPTION
The CRA requires all taxpayers to claim any capital gains on properties sold on their taxes each year.
However, the CRA makes an exception to this rule for properties that qualify as your principal residence.
If your home qualifies for the principal residence tax exemption, you won’t be required to pay capital gains tax on the profits realized from selling the property.
Over the past few years, the CRA has become stricter about verifying principal residence exemption claims. So, it’s important to understand how this tax exemption works before you claim it.
The CRA imposes capital gains taxes on real estate investors attempting to profit from the sale of a property. Some examples of this could include:
- House flippers (people who buy a property, fix it up, and sell it for more than they purchased it for)
- Those who purchase a property to rent it out to tenants, then eventually sell it
Currently, the capital gains tax in Canada is 50% on realized capital gains.
For example, if you purchase a $300,000 home as an investment and then sell it for $350,000 the following year, your capital gains would be $50,000. With a 50% capital gains tax, you must add only $25,000 (half of the $50,000 gain) to your taxable income for that year.
With this in mind, the principal residence tax exemption could help you save a significant amount of taxes that you’d otherwise pay when selling an investment property.
HOW THE CRA DETERMINES PRINCIPAL RESIDENCE
A principal residence is a property that the owner primarily uses to live in themselves. Although they may rent it out here and there or turn a profit later down the road, they primarily use the residence as a home for themselves and/or their families.
When determining principal residence, there tend to be many grey areas. The CRA does not designate a specific number of days you have to live in a property before it qualifies as a principal residence in any given year.
You don’t have to live in the residence full-time. However, taxpayers may have to prove that they physically lived in the property in the years that they designated the property as a principal residence.
If you claim the principal residence tax exemption after selling a home that you lived in, you’ll want to have some verifying evidence, in case the CRA decides to audit your claim.
If the CRA decides to investigate your claim of a principal residence exemption, they will look at it on a case-by-case basis and analyze all facts of the situation. Some things they might look into are:
- Utility bills addressed to your name
- How many days the property was rented out
- How many days you spent living on the property
- Your real estate transaction history
- Amount of capital gains earned on the sale of the property
- Rental income earned on the property
- Sources of income outside of real estate
The CRA will take a complete view of everything they investigated and use that information to determine if they will approve or deny your principal residence exemption.
Technically, anybody could claim that a property they sold was their principal residence. That is why the CRA looks closely into these claims. If the CRA believes your statement may be untruthful, they may contact you to verify the details of your residency.
CAN I RENT OUT MY PRINCIPAL RESIDENCE?
Contrary to your expectations, you can rent out your principal address and still receive the principal residence exemption. However, this depends on how many days you’ve rented a property out within a given year.
For example, many homeowners may rent their homes on a platform such as Airbnb while on vacation. In this case, you may still be eligible to receive the principal residence exemption. However, if your home is primarily rented to long-term tenants, then you won't receive the principal residence exemption for that year.
HOW MANY PRINCIPAL RESIDENCES CAN YOU HAVE?
Since 1982, the CRA has only allowed taxpayers to claim one principal residence per tax year. Even if you own multiple properties, you can only claim one as your primary residence.
CAN YOU HAVE A PRINCIPAL RESIDENCE OUTSIDE OF CANADA?
You can select a home in many countries as a principal residence. For example, you could have a primary residence listed in Puerto Rico or another Caribbean country. As long as you stay in the home more often than you rent it out, it should be eligible for the principal residence tax exemption.
THE CRA PRINCIPAL RESIDENCE CRACKDOWN
This tax exemption is a great incentive for Canadians to purchase real estate for themselves and their families. However, not everybody is truthful regarding how they report their recently sold homes.
If the CRA has reason to suspect that the property you sold may have been an investment property (as opposed to a principal residence), then you would be required to pay capital gains tax on any profits you made from the sale of the property. This can be determined even after receiving a principal residence exemption in the past.
Christopher Liew is a CFA Charterholder and former financial advisor. He writes personal finance tips for thousands of daily Canadian readers on his Wealth Awesome website.
Do you have a question, tip or story idea about personal finance? Please email us at firstname.lastname@example.org.
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