Tax season is upon us. Canadian tax residents must file tax returns for 2016 income with the Canada Revenue Agency (CRA) before the end of April 2017. Who is a Canadian tax resident? In principle, anyone for whom Canada is a home base is regarded as a tax resident.
In reporting income, Canadian tax residents also have to report any capital gains earned during the year, HOWEVER, unlike other income (such as income from employment, interest payments, rent, etc.) only ½ of capital gains are treated as income. In effect, therefore, the tax rate on capital gains is only ½ the tax rate on regular income. Moreover, there are a few types of capital gain that are entirely exempt from taxation. For most taxpayers the most important exemption from capital gains tax is for the capital gain earned on the sale of a family home known as the “principal residence exemption”.
Some of the key issues surrounding the principal residence exemption as follows:
- Q: Does a taxpayer have to report the capital gain on the sale of a principal residence?
Yes, the new policy requires the gain to be reported when tax returns are filed with CRA. This is a new requirement. The gain is only reportable for the taxation year in which the property is sold. If the property has, throughout the period it was owned by the taxpayer, been a principal residence then no tax is payable.
- Q: Who can claim the exemption?
The exemption is only available to Canadian tax residents who must declare world-wide income and capital gains when filing tax returns.
- Q: What type of property can be a principal residence?
Only “capital property” can be a principal residence. Property bought to “flip” is not “capital property”; it is inventory in a trading business where the profit from the sale of such property is treated as ordinary income, not even a capital gain. 100% of such gains are taxable. Only properties that were “ordinarily inhabited” by the taxpayer are eligible for the exemption.
- Q: Can different family members each own a “principal residence”?
There is only one residence that can be claimed by a family unit as a principal residence. Of course, adult children living apart from their parents are regarded as having their own family unit and are thereby entitled to claim an exemption for their own principal residence.
- Q: Are there penalties for failing to report?
If the sale is not reported in the tax return then CRA can, without any time limitation, audit the taxpayer at any time in the future. Moreover, taxpayers who have failed to designate the home as their principal residence could be subject to a late designation penalty of up to $8,000. It is expected that the new policy will give CRA auditors new audit leads and give rise to many more homeowner audits and re-assessments in the future.
In summary, anyone who sold their principal residences in in 2016 would be well-advised to report the sale and any associated capital gains in their tax returns for the 2016 fiscal year. Any questions concerning this new policy should be directed to experienced tax advisors.
Written by Peter Scarrow, former immigration lawyer, currently is the Director of Asian Business at Macdonald Real Estate Group.