Changes to principal residence rules

“It never made sense to me that someone could dispose of their residence without having to, at least, tell the CRA about it and then claim the exemption,” says Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce‘s wealth strategies group in Toronto. “Clearly, this was an area where there was tax avoidance going on by various people.”

In October, the federal government announced a raft of changes aimed at addressing risk in Canada’s booming housing sector and promoting tax fairness. These measures include introducing a more robust stress test for people applying for a mortgage, toughening the eligibility criteria for mortgage-loan insurance and closing a loophole that allowed non-residents to claim the PRE.

One of the most significant changes for Canadians, however, was a change in the CRA’s long-standing administrative position on claiming the PRE. Until this change, if a property was a taxpayer’s principal residence for every year in which he or she owned it, he or she didn’t have to report the sale on his or her tax return in order to claim the PRE.

Beginning in the 2016 tax year, the government will require individuals who wish to claim the PRE on the sale of a principal residence to report the proceeds of disposition, the date of acquisition and a description of the property sold on Schedule 3 of the tax return, which the government is amending for this purpose.

With the new rules, Golombek says, “the CRA will have the opportunity to look at everyone’s dispositions [of real estate].”

Taxpayers who fail to report and claim the PRE in the year of sale could ask to amend their tax return at a later date. However, under the proposed changes, the CRA would have the right to assess a penalty of $100 for each month after the original return due date during which the claim is not reported, up to $8,000.

“The CRA could apply penalties for simply not reporting the disposition, even though the client might not have any tax to pay,” says Aurèle Courcelles, assistant vice president of tax and estate planning with Investors Group Inc. in Winnipeg. “Now, the requirement to report on Schedule 3 will apply, whether there’s a taxable amount or not.”

The government has indicated that for dispositions in 2016, it will assess penalties in only the most excessive cases. The CRA will also have the right to reassess, beyond the normal three-year reassessment period, if a taxpayer fails to report a disposition of property on his or her tax return for the year in which the sale occurs.

Most clients, of course, will have a general idea of how the PRE works. When an individual sells a principal residence, or is deemed to have sold it, he or she doesn’t have to pay capital gains tax on the proceeds of disposition – as long at the property qualifies as the principal residence. Among other criteria, a principal residence is a residential property that a person or his or her family member lives in for any part of a year.

However, clients may not always be aware of some of the limitations by which properties are eligible for the PRE and can run afoul of the tax rules.

With the new reporting requirements, catching misuse of the PRE by taxpayers will be easier for the government to do.

“There’s going to be more people who will be surprised that what they assumed was a principal residence isn’t a principal residence,” says Keith Masterman, vice president of tax, retirement and estate planning at CI Investments Inc. in Toronto, “because now the CRA has a better method of tracking sales.” In making the changes, the government stated it wanted to “improve compliance and administration of the tax system with respect to dispositions of real estate.”

Golombek says the CRA was probably concerned about two main misuses of the PRE: taxpayers who claim the PRE for more than one property for the same tax year, and taxpayers who are engaged in repeated buying and selling of homes as a business.

Since 1982, family units have been able to designate only one principal residence for each tax year. Sometimes, Golombek says, taxpayers who own more than one property will sell one home, claim the PRE and then, years later, sell the other property and claim the PRE for that home, including for years in which they had already claimed the PRE for the first home. Under the CRA’s previous policy, taxpayers didn’t always have to report the sale of property in order to claim the PRE, so there was less chance of the CRA catching such misuse.

In addition, individuals might purchase, live in, renovate and sell homes on a frequent and repeated basis. With house prices booming in many markets, this practice has become more prevalent.

“If you do this once or twice, that’s one thing; there’s no problem,” Golombek says. “But if you’re in the business of doing this over and over again – in other words, you have no other job but renovating your home and selling it – then, really, you’re running a business.”

If the CRA determines that a taxpayer is in the business of flipping homes, then any gains in the disposition of property will be regarded as business income and not capital gains. The PRE would not be available in such situations.

Reporting the PRE in cases in which the taxpayer is not claiming it for all the years in which he or she owned the property is not changing. In those cases, the taxpayer will still have to file a CRA Form T2091 with that year’s tax return.

© 2016 Investment Executive. All rights reserved.