Guidelines for Principal Residence Exemption

Since the CRA changed it’s administrative policies back in 2016, the reporting of the disposition or deemed disposition of a principal residence has become more important in recent years.

The Principal Residence Exemption: As of the 2016 taxation year, it is now required that the sale of a principal residence property is reported and a designation of a principal residence is made in a taxpayer’s tax return in order to qualify for a tax exemption on the capital gains of the sale. Otherwise the full amount of the capital gains will be taxable if a taxpayer omits to report the deposition.

As with regular Canadian income tax reporting regulations, the reporting of the sale of a principal residence and designating the property as a principal residence is due on April 30th for individuals and on June 15th for those who operate a sole proprietorship.

If a taxpayer converts a property from a personal use property to an income earning property, or vice versa, then this would be considered a deemed disposition according to the the Income Tax Act.

A tax payer can be deemed to have disposed of their principal residence at fair market value if for example, they have moved out of their principal residence for the purpose of renting it out.

Here are some other scenarios which are not limited to the following, however which can result in a disposition or a deemed disposition of a residence.

  • – You moved into a property which was previously used as a rental property in which you are now occupying as your principal residence.
  • – The demolition of a house to construct a new home;
  • – The property was given as a gift (in part or in whole);
  • – Proceeds that were received from the expropriated property;
  • – Insurance proceeds from a flood or fire;

If you are late for filing the Principal Residence Exemption

If for whatever reason you omitted to designate your property as a principal residence in the year of the sale, here are a few considerations. For one, you can always request an amendment from the CRA to adjust your tax return to include the designation of your property for that taxation year, however you will incur a late filing penalty fee.

A late filing penalty is equal to the lesser of :

$8,000; or
$100 for each complete month after the original due date that the amendment request was made to CRA. For example: if the due date for a taxpayer was April 30th, yet the amendment was requested 6 months later, a penalty of $600 may incur.

45(2) Election to Defer Capital Gain on Change in Use from Principal Residence to Income-Producing Property

There are a few things to consider in the event that a tax payer decides to use their principal residence for income earning. Subsection 45 (2) will allow the property owner to elect out of being deemed to have disposed of the property at fair market value and reacquire it immediately thereafter at the same amount.

Until the taxpayer disposes of the property, the filing of subsection 45(2) would essentially declare that the taxpayer has not begun using the property for income earning purposes. This could remain in effect until either the property has been disposed of, or if the subsection 45(2) election has been rescinded.

The 45(2) election is required and due to be filed at tax time for the year in which the deemed disposition would have occurred.

Therefore let’s say that a taxpayer decided to move out of their principal residence in 2020, and rented it out in the same year ( 2020 ), in such a case, the property would be deemed to have been disposed of at the property’s fair market value in 2020 when filing the subsection (45) 2. The filing would be due on April 30th or on June 15th 2021 tax filing period.

Why Use 45(2) Election ?

If 45(2) election is made, it is possible to maintain a principal residence status for up to 4 years while the property is being rented out. It is also possible to delay the disposition until the property is disposed of, or if the election is rescinded. If you think a 45(2) election may be beneficial to you, you can talk to a member of DFD-CPA or send us an email.

Forgot to File 45(2) Election ?

As long as the taxpayer has not claimed any capital cost allowance for the rental property in question, in certain circumstances the CRA may accept a late-filed 45(2) election. However there is no guarantee that it will be accepted. This is totally at the discretion of the CRA and it becomes a potential penalty subject. So therefore, to avoid penalties, it would be advisable to file on time.

There is also less chance of the CRA accepting a late-filed 45(2) if the taxpayer owns multiple properties as this can be construed as retroactive tax planning.

45(3) Election to Defer Capital Gain on Change in Use of a Property from Income-Producing to Principal Residence

Let us now consider the reverse scenario. What if a taxpayer decided to change from an income-earning ( rental property ) to a principal residence ? In this case, a taxpayer can file for a subsection 45(3) which provides an election to avoid the deemed disposition on the change in use.

Filing of subsection 45(3) is due on the filing-due date for the taxation year in which the property is disposed of , or in some cases can be filed 90 days after the Minister requests the election to be filed.

Why use Election 45(3)?

Until the property is disposed of, a 45(3) Election allows the taxpayer to defer any capital gains accrued during the time that the property was rented out. However, this is only available if no capital allowance is claimed on the property. One main advantage is that it allows a taxpayer to go back four years when designating their property as a principal residence.

Budget 2019 Changes

Prior to March 19, 2019, subsection 45(2) and subsection 45(3) elections were only available when an entire property had a change in use. However Budget 2019 now applies even if there has been a deemed disposition that has arisen on the change in the use of even part of a given property.

If you still have questions about the Principal Residence Exemption, please contact a member of DFD-CPA today, by submitting a contact form inquiry.

As tax laws are complex and subject to frequent changes, it is therefore important to seek out the advice of a professional tax consultant, when considering implementing any tax planning.


Disclaimer:

This article only provides information in a general nature and is only as current as the date in which it is posted. It is not updated and therefore may no longer be current. This document should not be relied upon as it does not claim to, nor provide advice on legal or tax matters. All tax situations are specific in nature and will likely differ from the situations that are presented in the article. It is advisable that you seek and consult a tax professional if you have any specific legal or tax questions. This document is intended to provide general information on a particular subject or subjects(s) and this article is not an exhaustive treatment of such subject(s). In accordance, the information in this document is not intended to constitute or replace accounting, tax, legal, investment, consulting, or other professional advice or services. Before any decision is made, or any action taken which might affect your personal finances or business, you should consult a qualified, professional adviser.

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