The sale of your residential property may be exempt (or partially exempt) from taxation by the Canada Revenue Agency (CRA) if the property is designated as your principal residence. This designation is made at the time of sale or once the property is considered sold.
If your home was your principal residence for every year that you owned it, its sale would not be subject to tax, and would not need to be reported on your income tax return. However, to qualify as a principal residence, the property does not have to be where the taxpayer lives all the time. To be considered a principal residence, the following criteria apply:
- The property is owned solely by the taxpayer, or jointly with another person;
- The property was occupied by the taxpayer and/or his or her spouse, ex-spouse, common law partner or children during the year;
- The property is designated by the taxpayer as his or her principal residence (specified at the time of its sale or partial sale, for the years the property was used as one.
An individual can only designate one property as your principal residence in a given year. If a property has only been your principal residence for part of the time you owned it, part of the capital gain on its sale will be taxable. This portion is determined by a formula that factors the number of years the property was designated as a permanent residence, the capital gain on its sale, and the total number of years it was owned.
As per the CRA, spouses can only designate one principal residence between them for all years after 1981. If each spouse held their own principal residence before 1982, both homes qualify for principal residence status for the years prior. This is worth considering given that properties like cottages, condominiums, trailers and even live-on boats may be considered principal residences.
Many other factors may be considered in the calculation of the principal residence deduction, including: the repurposing of property (e.g. residential-turned-commercial spaces), the rental of property previously lived in, the amount of land that can be considered part of a principal residence, the fair market value of property, etc. In addition, the CRA has become more vigilant about “house flipping” trends and the application of principal residence deduction or exemption. Many factors are evaluated before deciding whether property sales should be considered as investment income (capital gain) or as business income. They include: the length of time the home is owned, the extent of repairs and renovations, the livelihood of the property owner, the frequency with which he or she sells real estate, and so on.
If you are a U.S. citizen or a green card holder living in Canada, the sale of your principal residence may result in undesirable consequences as the U.S. has significantly different regulations and definitions for what constitutes a primary residence.
One of the major differences is that the primary residence deduction available in the US can be used once every two years, and the home must be considered a primary residence for at least two out of the five years prior to the sale.
Another notable difference is the US definition of ‘ordinarily inhabited’ for tax purposes. In Canada, the question of whether a home is ordinarily inhabited in the year by a person must be resolved on the basis of the facts in each particular case. Even if a person inhabits a home for only a short period of time in the year, this is sufficient for the home to be considered ordinarily inhabited in the year by that person. For example, a summer cottage or other recreational property might be inhabited for only a week or two, but this time period is sufficient to allow it to be designated as ordinarily.
From a US tax perspective, it seems that a higher level of permanence and constancy is required for a property to be considered “ordinarily inhabited”, and therefore fit the mold of the Canadian definition. For example, the following factors should be considered in determining whether the principal residency deduction would be available on a US tax return for a US citizen living in Canada who disposed of his/her Canadian residence:
- His/her place of employment
- His/her principal living space of related family members
- The address listed on his/her federal/provincial tax returns, driver’s license, car registration and voter registration
- His/her mailing address for correspondence
Lastly, a major difference is that US rules allow for a maximum deduction of $500,000 from the gain on the sale of a primary home on jointly filed returns (maximum of $250,000 on single, married filing separately, or head of a household). These maximums are measured in US currency. Depending on the value of the Canadian dollar at time of sale and at time of purchase, as well as the closing and selling fees, these maximums may be enough to cover any gain on most properties. Any excess over these maximum amounts is subject to capital gain taxation. Furthermore, since the property will not be taxed in Canada, there are no foreign tax credits available on the US tax return.
To ensure that you benefit as much as possible from the principal residence deduction when selling your home, or for further information on how this might apply to a potential sale, contact RSW and let our tax specialist guide you.