Monday, October 09, 2006

Canadian Principal Residence Income Tax Exemption

Under the Income Tax Act, Canada, R.S.C. 1985, c. 1 (5th Supp.)when you buy land and later sell it at a profit, the profit may be subject to income tax. In some cases your profit is fully taxed. In others, it is treated as a capital gain, and half of the difference between the cost base and the funds you receive from the sale is brought into income.

But in the case of your residence, you may be able to claim an exemption from taxes on any gain on the residence when you sell it. Similarly, your executor or administrator may claim the principal residence exemption on your death, when tax law deems you to have disposed of your property. This is called the “principal residence exemption.”

You may claim a principal residence exemption in respect of only one property at a time. It may be a house, cottage, apartment, trailer, mobile home, houseboat or shares in a cooperative housing corporation.

You, or your spouse, common law partner, or child must ordinarily reside in the residence for it to qualify. A family unit, which includes spouses, common law partners, and unmarried children under 18, may only claim the exemption in respect of one residence at a time, for all years after 1981. (Before 1982, two spouses could each claim a different principal residence.)

If you reside in the residence, and then rent it out—or rent out, and then reside in the residence--you may claim the principal residence exemption for up to four years during the time you rent it out and remain a resident of Canada.

The Income Tax Act has restrictions on the size of land for which you can claim the principal residence exemption. Ordinarily, the building and up to one-half hectare of land will qualify. However, in some cases, a larger area of land may qualify, if the larger area is necessary for the use and enjoyment of the house as a residence. For example, if a larger area is necessary for access to the residence, or larger area is required to meet municipal bylaws respecting the size of lots, you may be able to claim the exemption in respect of more than one-half hectare.

If your land exceeds one-half hectare, and the excess land is not required for the use and enjoyment of the building as a residence, you may still claim the exemption in respect of the building and one-half hectare. Any gain on the sale will be apportioned between the land and buildings that qualify as the principal residence, and the excess land. There are special rules where the excess land is used for farming.

In some cases, a residence may be held in trust for someone. The residence may qualify as a principal residence if a beneficiary of a personal trust ordinarily resides in the residence. For example, in your will, you could provide that part of your estate will be held in trust for a disabled child. After your death, the trustee you appoint to manage the trust funds could, if authorized by your will, buy a residence for the disabled child. The trustee could then claim the house as the disabled child’s principal residence, and on a later sale of the house, claim the exemption.

You may also be interested in reading Canada Revenue Agency's Interpretation Bulletin IT-120R6 -- Principal Residence, and my earlier post on "B.C. Property Transfer Tax: Principal Residence Exemptions."

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