Under new rules (effective as of October 2016), Canadians are now required to report the sale of a principal residence. For most, this new rule is nothing more than a compliance exercise, albeit, one shadowed by the threat of unrestricted audits and sizable penalties.
To help maximize the capital gains tax strategies under this new rule
MoneySense has given us a list of tips to keep in mind.
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Report each sale
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A change in use is considered a sale
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You can still use strategies to minimize taxes
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Keep detailed records
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Be mindful if you own property through a trust
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Don't be surprised by these changes
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No more 1+ for foreign buyers
Tip #1: You must remember to report each sale
The new rules, announced in early October 2016, will require you to report every single property sale on your tax return. That means in your 2016 income tax return (due sometime in April 2017) you will need to report the sale of property, even if you don’t end up owing tax on the sale.
Fail to report the sale—whether intentionally or unintentionally—and you risk an audit, penalties and interest charges and the ability to shelter future home sales through the principal residence exemption (PRE).
Tip #2: A change in use is also considered a sale
Even if you haven’t actually put your home up for sale, the CRA will deem it to be sold if you change the use of the property. Take, for example, you decide to buy a new, larger home for your growing family but want to hold onto your current property and rent it out. The CRA considers this a “deemed disposition”—you haven’t actually transferred the ownership to another person, but you have changed the primary use of the property, from your family home to a rental property. As such, the CRA will consider the home sold, for tax purposes, at the current fair market value.
Tip #3: You can still use strategies to minimize taxes
For years, many Canadians minimized the amount of capital gains tax owed by strategically designating when each property was their principal residence, for tax purposes. To make this strategy work, however, the properties can not be income-producing during the years they are designated as a principal residence.
“Canadian families with a home and a cottage owned personally will be impacted by these new rules, as they’ll need to report the sale of each property,” explains John Sliskovic, private client services tax leader at EY LLP. “A family could still optimize the benefit of the principal residence exemption by designating the property with the greatest accrued gain as the principal residence.”
Example: Say you and your spouse bought a home in 2001 for $250,000. In 2002, you received an inheritance and bought a cottage about two hours away from Toronto for $200,000. For the next 14 years, until 2016, you and your spouse lived full-time in your city home and spent summers and holidays at the cottage. In that time, your family home appreciated and is now worth $650,000. During the same time period, the cottage’s fair market value rose to $725,000. Now you want to retire and part of that transition is to simplify your life by selling both properties and downsizing. If you needed to sell both properties this year, you’d end up having to pay capital gains tax on at least one—designate your city home and the exemption would save you from paying $60,000 in tax*; designate your cottage and the exemption would save you from paying $78,750 in tax. Already strategically choosing to shelter the property with the highest appreciation would save you $18,750 in tax. That’s not chump change. Talk to a tax specialist and you could further fine-tune this strategy to save even more on your taxes.
Tip #4: But now you have to keep much better records
While the new requirement to report all property sold in 2016 and in future years won’t impact strategic tax planning, it will put more onus on property owners to establish and keep better records. It will mean diligently keeping all receipts and invoices—an important aspect of real estate investment, particularly if you want to increase your adjusted cost base (ACB) on the property, and save tax later on when you go to actually sell the property.
Tip #5: Big changes if you own property through a trust
Families that own a home or cottage through a trust may be impacted in a different way. “The proposed changes limit the types of trusts that are eligible to designate a property as a principal residence,” says Sliskovic.
Example: a trust that is no longer eligible to designate the property as a principal residence under the new rules, but owns that property at the end of 2016, must separate its gain into two components: The gain accrued to 31 December 2016 may potentially be sheltered by the principal residence exemption, and the gain accruing from the beginning of 2017 to the date of disposition that will be subject to tax.
“Families that have utilized trusts to hold principal residences will need to carefully review the amendments and make any necessary changes to ensure that their estate planning is still appropriate,” explains Kim G. C. Moody, director, Canadian Tax Advisory at Moodys Gartner Tax Law LLP, in a
recent legal brief.
“Non-residents who utilized trusts to acquire property and claim the principal residence exemption will also be greatly affected,” explains Moody. With these new rules the strategic use of such trusts and similar “planning is now effectively dead.”
Tip #6: House-flippers watch out!
For real estate investors that specialize in buying, renovating and then quickly selling homes—a process known as house-flipping—the new reporting requirements will force you to justify the “ordinarily inhabited” rule.
As Moody explains: “The property also has to be a “capital property” of the taxpayer.” This means that it cannot be part of the trade of the business. This obviously isn’t the case for house-flippers. “House flippers are not eligible for the principal residence exemption since properties that are quickly sold after the acquisition will likely not be considered capital property but rather inventory,” writes Moody. As a result, any profits from selling the house are no longer considered a capital gain but rather as business income and would not be entitled to the principal residence exemption.
Tip #7: Don’t be surprised by these changes
The recent changes to how sold property is reported to the Canada Revenue Agency is not the first time the principal residence exemption has been significantly changed. One of the more significant changes occurred in the early 1980s, when each spouse was no longer allowed to claim a principal residence exemption for different properties (thereby enabling married couples to “double-up” on the benefits of the principal residence exemption). As a result, all family units are restricted to sharing the principal residence exemption for every calendar year for properties disposed of after 1981. While Federal Finance Minister Bill Morneau has stated that the feds are in a holding pattern right now, when it comes to the country’s real estate markets, don’t be surprised if additional changes are announced in the near future. Right now, the Liberal government wants to assess how recent changes have impacted each property market; if the shifts they are anticipating don’t transpire, it’s quite possible the federal government, or other levels of governments, will consider additional measures.
Tip #8: No more 1+ for foreign buyers
Anyone who was a non-resident of Canada in the year a property is bought, will no longer be able to automatically add a year to the number of years the property is considered a principal residence. (Tax specialists often point out that every Canadian is allowed to claim the PRE for each year the property is owned, plus one, effectively decreasing the capital gains taxes owed, where applicable.) This new rule applies to any property sold (or deemed to have been sold) after October 3, 2016.
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