The principal residence exemption is one of the largest tax breaks in the Canadian personal tax system. It can entirely eliminate tax on capital gain incurred when a principal residence is sold. For a property to qualify as your principal residence in a given tax year, you must first own it in that year, or own it jointly with another person.
Second, you or your spouse/common-law partner, your former spouse/common-law partner, or your child must occupy or "ordinarily inhabit" the residence. If you leave a principal residence and rent it out, it can usually continue to qualify as your principal residence for up to 4 years, provided a valid election is filed in your tax return for the year when the change occurs.
Third, you can designate only one property as your principal residence for a specific taxation year. And, since 1982, only one property per family unit can be named the principal residence.
If you've sold your farm this year and it included your principal residence, you need to be aware of tax issues surrounding the principal residence exemption. These include:
- Tax rules regarding the sale of land in excess of half a hectare (one acre).
- The two methods for calculating a principal residence exemption.
- Canada Revenue Agency (CRA) filing requirements regarding sale of a principal residence.
The Income Tax Act states that if land on which a taxpayer's house is located is not more than half a hectare in size, it is normally part of the principal residence. Since the late 80s, however, numerous taxpayers have challenged the half-hectare restriction in court â€” and won. So today, a principal residence may include land in excess of half a hectare if you can demonstrate that the extra land was necessary for "use and enjoyment" of the home.
For example, the size or character of a house, together with its location on the lot, may make excess land essential to its use and enjoyment as a residence. Or excess land might be needed for access to public roads.
Local zoning laws often dictate the need for excess land, through either minimum lot sizes or restrictions on subdividing or selling off part of a property. Existence of such a municipal law or regulation at the time a taxpayer bought a property does not immediately qualify the excess land for principal residence exemption. If the taxpayer could have made an application for severance of the excess land â€” and it is likely the request would have been approved â€” the land would not usually be considered to have been required.
In addition, any portion of the land in excess of half a hectare that has been used for farming or other income-generating purposes would be viewed as business property subject to normal capital gains tax treatment.
If you've sold farmland that includes your principal residence, you can calculate any gain on disposition of the property by either of 2 methods.
Under the first method, you treat the property as being divided into 2 portions â€” principal residence and remainder, part or all of which was used in your farming business. To calculate capital gain for each portion, proceeds of disposition and adjusted cost base of the entire property must be allocated on a reasonable basis. Gain attributable to the principal residence is normally exempt.
The second method lets you calculate gain on disposition of the total property, without any allocation and without claiming the principal residence exemption. Capital gain on the total property is then the gain as calculated, less the total of $1,000 plus $1,000 for each taxation year for which this was your principal residence following the later of the year of acquisition or December 31, 1971.
Yes, the choice can be complicated. You'd be wise to talk with your tax advisor before deciding which method is best for you.
If you have been claiming capital cost allowance on a portion of your dwelling (usually considered inadvisable), the exemption otherwise available is reduced by that portion.
Technically speaking, to claim the principal residence exemption, the Income Tax Act requires that Form T2091, designating the property as your principal residence, be filed with your tax return for the year you sell the property. Administratively, though, CRA seems to require a T2091 only if the principal residence exemption does not completely eliminate the gain on sale of the property â€” or where the one-time capital gains crystallization election was claimed on a taxpayer's 1994 tax return.
It might be best, however, to file a T2091 to safeguard your exemption, particularly if any question exists about the whole principal residence exemption being available. This situation arises, for example, when the property is more than half a hectare in size, or if it's uncertain whether you lived there during any year for which the exemption is claimed.