Principal Residence: Tax Consequences of Sale
Generally, when real estate is sold, the seller will pay some tax on the proceeds. The Principal Residence Exemption (the “PRE”), as explained under the Income Tax Act, allows qualifying sellers to reduce or eliminate paying tax on the capital gain from the sale of their home. However, the rules are specific, and missing key requirements can result in costly reassessments. Here’s what you need to know to ensure you are eligible and to protect yourself from unexpected tax liability.
What is PRE?
The PRE is a tax benefit that lets you exclude the capital gain from the sale of your principal residence from your taxable income, provided you meet certain conditions. This means that, for most Canadians, selling your principal residence will not trigger a capital gains tax.
Conditions to Qualify as a Principal Residence
To claim the PRE, your property must meet several criteria:
Ownership
The property must be beneficially owned by the you, even if not legally, to claim exemption; this includes joint ownership with another person.
Ordinary Habitation
The property must be “ordinarily inhabited” by you, your spouse or common-law partner, or your child at some point during the tax year to claim the exemption. Even short periods of occupancy may qualify.
Designation
The property must be designated as a principal residence in the year of the sale through filing Form T2091(IND), which is submitted with the annual tax return.
Note: If this designation was not made, you can apply for the acceptance of a late-filled designation, however, penalties may apply.
Minimum Holding Period (For Sales After January 1, 2023)
Starting January 1, 2023, any gain from selling a Canadian housing unit, held for less than 365 days, is treated as business income, not a capital gain, unless the property was inventory or the sale resulted from certain life events. This rule targets property “flipping” and aims to tax short-term housing profits more strictly.
Intent to Flip
The subject property must not have been purchased with the intent of “flipping” the property for profit – specifically, the sale of the property must result in a capital gain as opposed to “business income”. Even if held for over a year, a property can still be considered “flipped” based on the specific details of the sale.
How the Principal Residence Exemption Works
The PRE is not an all-or-nothing benefit. Its effect is determined by a specific formula:
Exempt Gain = number of years in home as principal residence + 1
number of years home is owned
Capital Gain
This means that even if your home was not your principal residence for the entire ownership period, you can still claim a prorated exemption for the years it qualified. If the property was your principal residence every year you own it, the entire capital gain is tax-exempt.
Only one property per family unit can be designated as a principal residence each year.
Best Practices
Residential property sales are frequently subject to CRA scrutiny. A pattern of frequently buying and selling houses may precipitate further investigation. The principal residence exemption is most frequently denied on the basis that the property was not “ordinarily inhabited” by you or an eligible family member, or that it was purchased and sold in an “adventure or concern in the nature of trade” such that the profits constitute business income.
A simple statement of intent to inhabit the property is not enough. You must be able to provide concrete evidence of your occupancy and intention. Examples of supporting documentation include:
- Utility bills and financial statements listing the subject property as your address;
- Other important mail addressed to the subject property;
- Records of address changes to the subject property;
- School records for children;
- Evidence of a parking spot used near the subject property;
- Receipts of deliveries that were made to the subject property;
- Home insurance bills; and
- Photos evidencing inhabitation within the subject property.
There are multiple factors that are considered holistically in determining whether a transaction constitutes an “adventure or concern in the nature of trade”. At the CRA Audit, Appeals, and Tax Court of Canada stage, each case is decided on its particularized facts. For this reason, you are well advised to consult with a tax professional if they are planning on selling real estate or if a prior real estate sale is being reviewed by the CRA.
***Disclaimer: This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions, you should consult a lawyer.
