News Articles

The Tax Free Sale of a Principal Residence

As most residents of Canada are aware, the Income Tax Act will usually permit the sale of a person's "principal residence" on a tax free basis.  However, the circumstances under which a fully tax free sale is permitted are fairly restricted, and a person is well advised to discuss this matter with their legal or accounting advisors to avoid some of the pitfalls and to take advantage of the benefits of the Income Tax Act.  This article will address some of the situations that can affect the availability of the principle residence exemption, but is in no way intended to be a comprehensive discussion.

To qualify as a principal residence, the residence must be one of the types listed in the Income Tax Act, including but not limited to, a house, cottage, mobile home, houseboat, or condominium.  The principal residence must be owned, either alone or jointly with another person(s), by the individual claiming the exemption, and it must be "ordinarily inhabited" by one of the persons comprising the individual's "family unit", which includes the individual, his or her spouse, former spouse (in some cases), or minor children. 

Where members of a family unit own more than one property in a year, only one of the properties can be designated as their principal residence.  This rule can be a minefield for spouses who have separated and who now each own their own home.  Potentially, only one of the two homes can be designated as the principal residence for the two of them, even though they are separated.  If one of them is later sold, tax may be assessed on the gain unless the separated spouses strictly comply with the provisions of the Income Tax Act.  Among other things, they must have a judicial separation order or written separation agreement in place.  People who are not married but living together may also be caught by this rule, because the Income Tax Act extends the definition of spouse to include "common law partners" (you should consult your tax adviser for more information on this term).

The reverse of this situation can also lead to some complications.  For example, where two individuals who each own a home decide to cohabitate in one of the residences and rent the other residence to tenants, when the rented residence is no longer inhabited by the owner it is no longer a principal residence.  When the owner finally sells the property, tax will be payable on any gain realized between the time it was no longer inhabited by the owner and the date of sale.

Another issue that commonly arises with respect to the principal residence exemption relates to the size of the property upon which the residence is situated.  Typically, if the land on which the housing unit is situated is not in excess of one-half hectare, it usually qualifies as part of the individual's principal residence.  Land in excess of one-half hectare may also qualify, but only to the extent that it is necessary for the use and enjoyment of the housing unit as a residence.  If the land in excess of one-half hectare does not qualify, there will be a taxable gain on the sale of the excess when it is sold along with the principal residence.  A similar situation may result for those individuals who own farm property and whose principal residence is on the farm.  Upon the sale of the farm, only the principal residence and the portion of land required for its use and enjoyment as a residence may be exempt from tax on the sale of the entire farm.

If an individual acquires land in one year and constructs a residence on it in a subsequent year, the property cannot be designated as the person's principal residence for the years in which it was not inhabited by the individual (or someone from the individual's family unit).  Any gain on the value of the land prior to commencement of habitation will be taxable upon the later sale of the property.

If a portion of the principal residence is used to earn income, such as a home-based business, that portion of the residence may not qualify for the principal residence exemption upon the sale of the property.

Finally, it should be remembered that since a principal residence is exempt from capital gains tax upon its sale, if it is sold for a loss, no deductions are permitted against other income or capital gains.

For most individuals in Canada, who own one residence and within which their "family unit" resides, there are few concerns with respect to its sale and the availability of the principal residence exemption.  That is, for most people a gain on the sale of their home is a non-taxable event.  However, there are a variety of situations that can occur which could make the issue very complex.  The foregoing was intended to illustrate only a few of the issues that may arise when dealing with what is believed to be the "income tax exempt" sale of a home.  In all cases, whether buying or selling property, it is highly recommended that you seek professional tax advice from your legal or accounting advisors to avoid any pitfalls and to take advantage of any tax benefits that may be available.

By Tom Langford
November 27, 2002