Principal residence and capital gains
It’s a complex area, but worth learning if you dabble in real estate
Excerpt from an article by David Cruise and Alison Griffiths - Toronto Star
The only people more content than investors who bought energy stocks back in the $30-a-barrel-of-crude days are those who purchased real estate during the doldrums and are now sitting on fat nest eggs.
Two such are Andy and Isabelle Ruiz.
“My wife and I bought a home in British Columbia back in 1988,” Andy writes. “We did extensive renovations and it was worth about $425,000 when we moved to Ontario in 1993. The house has been rented ever since.”
After more than a decade of sagging real estate prices, their home on the west coast has shot up to $650,000, causing the Ruizes to consider making some hay in the shining sun by selling while the market is still hot.
These are important questions because these days, what the market gives, in terms of real estate gains, can be partially taken away by capital gains. Cottage owners, for instance, who want to take advantage of Muskoka price madness may be affected, just as investment property owners are.We spent a couple of hours browsing the Canada Revenue Agency website. Two splitting headaches later, about the only thing we learned for sure from the CRA’s convoluted caveats and if-this-then-that examples, was that if you reside in your home from the time you buy it to the time you sell it, you are not subject to capital gains tax unless you have already designated another place as your principal residence during that period.
The website of Toronto chartered accountant, Joseph Tavana, is much clearer. (Go to http://www.tavana.ca, click newsletters then Your Principal Residence and Taxes.)
“The first thing we need to understand is that when these individuals moved to Ontario in 1993 and changed the house to a rental property, the CRA deems that it’s disposed of and reacquired,” Tavana notes.
“At that point in time they could have made a principal residence election on their 1993 tax form, which would have extended their residency by four years.”
The Ruizes neglected to do this 13 years ago. Fortunately, all is not lost. The principal residence designation can be made later - in fact, right up until the time the property is sold - as long as it doesn’t cover a period they already designated a principal residence for tax purposes.
Andy and Isabelle believe their house was worth $425,000 when they converted it to a rental property. If substantiated, that figure becomes the base price for any later capital gains calculation.
“Generally speaking, short of an official appraisal done by a realtor or professional appraiser, they could use printouts from MLS of similar houses and locations, which can be used to extrapolate value,” explains Tavana.
The Ruizes bought another house in Ontario in 1993, sold it in 1997, purchased a second house that year and then sold it in 2001. Because they declared both houses to be principal residences, they can’t now designate the B.C. property to be a principal residence for those years.
But, since they have been renting, the Ruizes, if they move back to B.C., will be allowed to elect the B.C. house as their principal residence for a maximum of four years plus one.
Let’s say the Ruizes do not move into the home but sell it this year for the projected $650,000. The difference between that price and the estimated value in 1993 is the capital gain - in this case, $225,000.
Of that, only half, or $112,500, is taxable. The amount is treated as income by CRA and can be split between the two of them. Assuming a 40 per cent tax rate they would each have to pay $22,500.
However, if our readers do move back into the house for a period of time and then sell it, the capital gain hit will be smaller. Because they’ve been renting since 2001, they can designate the B.C. home as their principal residence for the previous four years plus one, producing a capital gains exemption.
To calculate the exemption, multiply the taxable gain ($112,500) by the number of years the house can be designated a principal residence (in this case the four year maximum plus one), and then divide by the number of years, 13 in this case, since the house was converted to a rental.
Assuming the Ruizes had moved back early in 2006, then sold the house later that year, the formula would look like this: $112,500 times 5, divided by 13. The capital games exemption would be $43,269, leaving $69,231 taxable as income, which could again be divided between husband and wife.
Assuming the 40 per cent tax rate, the tax payable would be a total of $27,692 ($13,846 each) or $17,308 less than if they had sold without returning to the house and without designating it as their principal residence for the four previous years.
The way the CRA formula works, if the Ruizes return to B.C., the longer they stay in the home before selling it, the higher the capital gain exemption - assuming the sale price remains the same.
For example, if they sell in 2007 they add an additional year to both the top and bottom of the formula, so it looks like this: $112,500 multiplied by 6 over 14. The exemption then increases to $48,214.
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