Hello fellow Realtors, mortgage brokers, conveyancers and clients, you may or may not have heard about recent tax changes regarding the principal residence exemption available on the sale of a taxpayer’s principal residence. The recent changes are significant and I would consider them to be a TAX TRAP because the new rules now require positive action by the taxpayer to claim the exemption and failing to claim the exemption will result in taxes being reassessed on the taxable capital gain.
The ”One-Plus” Rule
The formula used to calculate the principal residence exemption is:
B = the number of years your home is your principal residence AND you were resident in Canada; and,
C = total number of years of ownership.
The “one-plus” portion of the formula enables a taxpayer to purchase a home in a given year and sell their former home in the same calendar year and still be able to claim both residences in the same year as their principal residence. In other words, the “one-plus” rule enables an overlap of one year whereby both residences would still qualify for the principal residence exemption. If both properties are owned for more than one year then one of those properties would be disqualified from claiming the principal residence for the years that the second property is not claimed as the principal residence.
The Department of Finance indicated that the One-Plus rule was not intended to apply to non-residents of Canada. Therefore, effective October 2, 2016, the one-plus rule will only apply to persons resident in Canada in the year the person acquires the property. The effect of this change is that non-resident buyers would not be able to claim the principal residence exemption in respect of the subject property for the year in which the property was purchased. This effectively creates a situation whereby your client may be partially subject to tax on the capital gain when the property is eventually disposed.
Positive Reporting Requirement for Disposals of Principal Residence
By way of legislation, taxpayers have always been required to report the sale of their principal residence and claim the principal residence exemption in order to avoid paying taxes on the capital gain on the sale of their principal residence. Historically, the Canada Revenue Agency (“CRA”) did not require taxpayers to report the capital gain if the entire capital gain is waived due to utilization of the principal residence exemption. This meant that no additional action on the part of the taxpayer was required to avoid paying taxes on the capital gain.
Effective January 1, 2016, ALL taxpayers will have to report the sale of their principal residence on their personal tax return in the year in which the sale occurred. In other words, for all of your clients that disposed of their principal residence in 2016, they will need to report the sale on their 2016 personal tax return which is due April 30, 2017. The taxpayer would report the disposition on Schedule 3 Summary of Dispositions – Capital Gains (or Losses) AND claim the principal residence exemption by filing Form T2091 to designate the home as a principal residence for any given year. This means that taxpayers MUST file the election to utilize the principal residence exemption, otherwise, taxes would be calculated on the taxable capital gain. Given the current market, the taxes on the capital gain would be significant.
If taxpayers forget to file, then they would need to file an amended return for the year in which the disposal took place. The CRA indicated that they will treat the filing of Form T2091 as an election; accordingly, filing a late election will trigger a late filing penalty at the lower of $8,000 or $100 for each complete month from the original filing due date to the date that the form is filed.
For more information regarding the reporting of the sale of your principal residence, you can refer to this (click here) webpage from the Canada Revenue Agency.
Statute-Barred Period for Reassessment
Normally, the statute-barred period for the CRA to be able to reassess a tax return is 3 years from the date of the notice of assessment for that tax year. However, in the case of failing to report the disposition of real property (regardless of whether the real property was a principal residence), the statute-barred period is indefinite. This means that the CRA can go back indefinitely to impose taxes on capital gains that were not reported on the sale of real property occurring in 2016 and later tax years. For example, your client sells their real property (principal residence or investment property) in 2016 but forgets to report the disposition. Fifteen years later, the CRA catches wind of your client’s failure to report. The CRA can go back and recalculate the taxes payable as at the year in which the sale took place. This will result in taxes payable. Further, because the taxes were not paid by the due date (15 years ago), the CRA will also charge interest going back 15 years! Even at fairly low prescribed interest rates, interest on a significant taxes payable balance over 15 years is a lot of money.
Your clients do not expect you to be tax experts (that’s my role); however, your clients may expect you to know enough to tell them about a potential issue and to refer them on to a professional who can help them (nudge… this is where I hope you would refer your clients to me). Even if your clients don’t have that expectation of you, what a hero you’d be in your clients’ eyes if you simply brought this issue to their attention. The mere mention of the potential issue is a clear demonstration of the extraordinary client service that you provide to your clients.
As always, please let me know if you have any questions. I’d be extremely pleased to be a resource for you and your clients.