Principal residence … principally tax free

By Mylene Tremblay
Courtesy of Deloitte 
 
As many taxpayers know, the sale of a principal residence is usually tax free. What most people do not know is that to qualify as a principal residence a property does not have to be the one in which the taxpayer spends most of his/her time.
Taxpayers can claim the principal residence exemption on the sale of their principal residence if all of the following conditions are met:

• During the year, the taxpayer owns the property
• The residence is ordinarily inhabited during the year by the taxpayer, or his or her spouse, common-law partner, ex-spouse, former common-law partner, or child
• A designation is made in the taxpayer’s tax return for the year of the sale

So, what qualifies? A house, condominium, mobile home, trailer, houseboat, and cottage are all typical examples. Even a home in the U.S. or another foreign country could qualify. The tax authorities take the position that a secondary residence may be considered “ordinarily inhabited” even if the taxpayer only lives there during vacations, provided that the property is not primarily owned to generate income. As a result, a secondary residence can be rented out occasionally without losing eligibility for the principal residence exemption.

In addition, the definition of “principal residence” includes up to half a hectare (about 1.25 acres) of land on which the residence is situated. If the total land area on which the residence is located exceeds half a hectare, the land is not usually eligible as a component of the principal residence, unless the taxpayer can show that the excess area is necessary for use of the residence.

According to the rules, since 1982 only one residence can be designated a principal residence per family per year. A taxpayer who owns two or more properties must determine which will be designated the principal residence for each year. However, the designation does not have to be made annually — it only needs to be made when selling one of the residences. At that time you would need to review the annual increase in value for both homes, and make a rough estimate of when the second property is likely be sold. This review, coupled with a few “what if” models using the exemption formula, would assist in your decision.

Even if only one property can be designated as the principal residence in a given year, the exemption calculation formula provides for the addition of one exemption year. Intended to preserve the exemption during the year in which an individual sells his/her residence and buys another one, this rule also gives taxpayers who own multiple properties the benefit of an additional exemption year with respect to any of their residences.

In conclusion, if you own more than one residence, you should determine the current and future capital gain for each to evaluate the tax consequences that would arise if each were sold. That way, the principal residence exemption can be maximized and your tax burden minimized.

Mylene Tremblay is a tax manager in Montreal.