Principal residence disposition

The sale of a principal residence can be a complex transaction to enter on a tax return. Let’s have a look in detail at some of the concepts as well as other considerations that have to be taken into account when designating a property as a principal residence.

Basic Definition of a Principal Residence

The basic definition of a principal residence, as outlined in section 54 of the Income Tax Act (ITA), is any housing unit owned by the taxpayer, which he or she, or someone related to that taxpayer, ordinarily inhabited during a particular year, and is designated as a principal residence at the time of sale.  The taxpayer can designate the years he /she resided in the housing unit for an exemption of capital gains under paragraph 40(2)(b) of the ITA.

Five important criteria to consider when determining the principal residence designation

The definition itself can be broken down to five important elements, which will be developed further:

a)      The sale is related to a disposition of what the CRA calls a “housing unit”;

b)      The taxpayer is the owner of the property;

c)       The taxpayer  or someone related to the taxpayer “ordinarily inhabited”  the housing unit;

d)      Land attached to the housing unit is included as part of the principal residence;

e)      You must designate the housing unit as a principal residence.

Housing Unit

As per paragraph 2.7 of S1-F3-C2 Income Tax folio, an eligible housing unit includes:

         i.            a housing unit, which the CRA has accepted could include:

o   a house;

o   an apartment or unit in a duplex, apartment building or condominium;

o   a cottage;

o   a mobile home;

o   a trailer; or

o   a houseboat.

a leasehold interest in a housing unit; or

a share of the capital stock of a cooperative housing corporation, if such share is acquired for the sole purpose of obtaining the right to inhabit a housing unit owned by that corporation.

http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s1/f3/s1-f3-c2-eng.html#N10293

Taxpayer is the owner

The taxpayer making the designation has to be the owner of the property as per paragraph (a) of section 54 of the ITA. The taxpayer does not have to be the sole owner of the property to qualify it as a principal residence (ITA 54(a)).

Taxpayer or someone related to the taxpayer ordinarily inhabited the housing unit

As per paragraph (a) of section 54 of the ITA (“principal residence”), the taxpayer (owner) has “ordinarily inhabited” the property if he/she (or the taxpayer’s spouse or common-law partner, ex-spouse or common-law partner, or the taxpayer’s children) lived in the property.

“Ordinarily inhabited” is a tricky term when it comes to a principal residence. Unfortunately, the ITA does not give a detailed description of what the CRA considers as “ordinarily inhabited”. To answer this question, we will rely on the administrative position of the CRA.  As per paragraph 2.10 of folio S1-F3-C2, the question as to whether the taxpayer ordinarily inhabited a property is based on the facts of the each particular case. There is no requirement that the taxpayer stay for long periods in the housing unit; if the taxpayer lives for a short period of time in the year, this is sufficient for the housing unit to be considered ordinarily inhabited in the year by that person. Again there is some ambiguity to this definition. What is a “short period”? We don’t have a clear answer to this question; however, we can confirm from case law that it has to be more than a 24-hour stay (Ennist v. Minister of National Revenue).  What the “ordinarily inhabited” provision allows a taxpayer to do is to designate a secondary residence as a principal residence. However, the taxpayer can only designate one property for a particular year (ITA 54(c) “principal residence”).

Land attached to the housing unit is included as part of the principal residence

As per paragraph (e) of section 54 of the ITA (“principal residence”), the land upon which the housing unit stands and any portion of the adjoining land are considered part of the housing unit, up to one-half hectare.  As per paragraphs 2.33 to 2.35 of folio S1-F3-C2, the taxpayer can claim more than a one-half hectare; however, he/she would have to prove that the excess land must clearly be necessary for the housing unit to properly fulfill its function as a residence.  Considerations to take into account for the excess land are, for example, minimum lot size for a residential lot in a particular area, or imposition of a severance or subdivision restriction with respect to a residential lot in a particular area restricting the lot from being one-half hectare or below.

You must designate the housing unit as a principal residence - ITA 40(2)(b)

In order to achieve the exemption given for a disposition of a principal residence, the taxpayer must designate the property as a principal residence for the years he/she “ordinarily inhabited” the property (see above). When making the designation, the taxable gain is determined according to a formula provided in subparagraph 40(2)(b) of the ITA:

A - {A × (B ÷ C)} - D

A is the taxpayer’s gain otherwise determined;

B is 1 + the number of tax years ending after the acquisition date for which the property was the taxpayer’s principal residence and during which he or she was resident in Canada. (Note that both these conditions must be satisfied for a particular year in order for that year to qualify for inclusion in variable B.);

C is the number of tax years ending after the acquisition date during which the taxpayer owned the property;

D relates to the 1994 capital gains exemption election.

http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s1/f3/s1-f3-c2-eng.html#N103EF

As per paragraph (c) of section 54 of the ITA (“principal residence”), the taxpayer can only designate one property per year (as mentioned above). This provision also applies to people related to the taxpayer. No other property may have been designated as the principal residence of any member of the taxpayer’s family unit for the year, unless the year is before 1982. For years after 1981, the family unit is defined in ITA 54(c) (“principal residence”) as:

       ii.            the taxpayer’s spouse or common-law partner throughout the year, unless the spouse or common-law partner was throughout the year living apart from, and was separated under a judicial separation or written separation agreement from, the taxpayer;

      iii.            the taxpayer’s children, except those who were married, in a common-law partnership or 18 years of age or older during the year; and

     iv.            where the taxpayer was not married, in a common-law partnership or 18 years of age or older during the year:

o   the taxpayer’s mother and father; and

o   the taxpayer’s brothers and sisters who were not married, in a common-law partnership or 18 years of age or older during the year.

http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s1/f3/s1-f3-c2-eng.html#p2.13

Designation of a house purchased before December 31, 1981 - ITA 40(6)

When designating a housing unit that was purchased before the 31st of December 1981, the capital gain determined under the rules of ITA 40(2)(b) cannot exceed the total of the following calculation:

a)      the taxpayer’s gain calculated in accordance with paragraph 40(2)(b) on the assumption that the taxpayer had disposed of the property on December 31, 1981, for proceeds of disposition equal to its fair market value on that date, and

b)      the taxpayer’s gain calculated in accordance with paragraph 40(2)(b) on the assumption that that paragraph applies and that

                     i.            the taxpayer acquired the property on January 1, 1982, at a cost equal to its proceeds of disposition as determined under paragraph 40(6)(a), and

                   ii.            the description of B in paragraph 40(2)(b) is read without reference to “one plus”.

http://laws-lois.justice.gc.ca/eng/acts/I-3.3/page-30.html#docCont

Once you compute the taxable capital gains based on both formulas, you must choose the one that gives the lowest amount.

In the second instalment of “Principal Residence”, we will discuss special topics that affect principal residence designations.