Hard to believe it is already fall! The beautiful weather has extended summer. As the cold weather arrives and many clients begin to close up their cottages for the season I am often asked: what will happen when I sell the cottage? Will the sale be tax free? I believe it is common knowledge that the sale of your home is tax free. However many folks now own more than one property. Having a cottage or vacation property can make things more complex. Ensuring you use the Principal Residence Exemption (PRE) correctly can help you save thousands of dollars in tax.
For starters the PRE allows you to sell your home tax free. You do not have to pay tax on the increase in the value of the home. For example if you purchased a home for $50,000 and many years later you sold it for $300,000, with the PRE the entire $250,000 capital gain would be tax free. To qualify as “your home” the property most be a residential property that is ordinarily inhabited by you, your spouse (or former spouse), common-law partner or children. Mobile homes, houseboats, cottages, vacation property, even foreign vacation property can qualify. You do not have to live in the home for a specific time period to meet the “ordinarily inhabited” criteria; if you sleep there on occasion it essentially passes the test. However vacant land does not qualify, nor does rental property. It is also important to note that large properties and farmhouses have additional requirements.
Only one PRE can be claimed for each married or common law couple. There are a handful of exceptions, for years of ownership prior to 1982 married couples are allowed to claim two principal residences and for years of ownership prior to 1994 common law couples can claim two principal residences. Laws were slower to change for same-sex couples, for years of ownership up to 2001, same-sex couples can claim two PREs.
Apart from those exceptions, couples can only claim one PRE. Meaning if you have multiple properties careful planning is required to minimize your overall tax bill. A simple guide is to use the PRE on the property that is expected to have the greatest capital gain.
If you have one residence and you sell it you do not have to claim the sale on your tax return, the PRE is assumed. If however you have multiple properties and you sell one of them, but do not want to use your PRE on that property (perhaps saving it for the eventual sale of a second property with a larger capital gain), you need to file form T2091 (IND). Be sure to use this form, if you do not you will lose the right to claim your PRE for the years you owned the first property and the eventual sale of the second property will result in a larger tax bill.
Proper understanding and use of the PRE can save you thousands of dollars in tax. A full discussion of the PRE can be part of your overall estate plan and insurance plan. It is best to consult your accountant and advisors before implementing any strategy.
This information transmitted is intended to provide general guidance on matters of interest for the personal use of the reader who accepts full responsibility for its use, and is not to be considered a definitive analysis of the law and factual situation of any particular individual or entity. As such, it should not be used as a substitute for consultation with a professional accounting, tax, legal or other professional advisor. This commentary reflects my opinions alone, and may not reflect the views of National Bank Financial Group.