Depending on the assessed value, you could avoid paying tax even if you realize a profit
Q: I purchased a condo in 2005 for $212,000. At that time I spent about $50,000 on home renovations and improvements. I lived in the condo until October 2012, when I got married and moved into my husband’s house. At this time, I did not think of having the condo appraised.
Between when I moved out until August 2013, the condo sat empty (I was unsure if I would sell or rent). The 2010 B.C. tax assessment valued the property at $312,000, but five years later the same assessment department valued the property at $252,000. Neither value takes into consideration the $50,000 I put into upgrades.
Now, I have a buyer who will give me $310,000 for the condo, but I’m not sure what I will owe in capital gains tax. Considering I’m retired and live on pensions, I’d appreciate any insight.
— Curious about capital gains tax owed, Kelowna, B.C.
Answer from George Dube, real estate tax specialist: Quite often tax-related queries are simple questions with complex answers. This is exactly what I mean. While this real estate investor simply wants to know the tax burden on the sale of their rental condo, the answer depends on a number of factors.
To find an answer, we need to be clear about the timeline:
She lived in the condo from 2005 to 2012.
The condo was vacant from October 2012 to August 2013.
The condo was rented from September 2013 to 2015.
We’ll also assume that up until 2012, the condo was the only property owned and the only property that could be declared as a principal residence.
Based on these facts and assumptions, and to consider the possible capital gains owed, we need to consider two concepts: the principal residence exemption and the change in use of the condo.
Principal residence exemption
When a property is your principal residence (i.e. where you live), you are generally exempt from paying capital gains tax when you sell it. However, when a property changes use—for instance, it goes from being your primary residence to a rental property—the principal residence exemption is affected.
Also, because you are married, you and your husband may only designate one property per year as your principal residence. Starting in 2012, your principal residence became his house, which means the condo went through a change of use in that year.
What is change in use?
According to the Canada Revenue Agency, every time you “change the use” of a property, it’s considered to have been sold at fair market value. (Under CRA rules, a change in use translates to a deemed disposition, which, in simple terms, means you theoretically sold the property at fair market value when you decided to change its use.)
Now, under tax rules, you have to report the resulting capital gain or loss in the year the change in use occurs. However, you only have to report the gain that relates to the years your home was not your principal residence. In your case, you would be capital gains tax on three out of the 15 years you owned the condo—or, put another way, you’d pay tax on one fifth of the full appreciation on this property.
Now, under CRA rules you can also defer paying those capital gains until you actually sell the property. Also, you have a complicating factor as there is, theoretically, a capital loss on your property. As such, it’s important to go through the calculations on this property.
Capital gains calculation
In your case, you lived in the condo before you started renting out the property, so there was a change in use. Here’s how the calculations work out:
Your cost = $212,000 + $50,000 = $262,000
Fair Market Value (2012) = $312,000
So, you can shield $50,000 in capital gains on this property because it was a principal residence during these years.
Now, if you sold the property in 2015, you would have a capital loss, based on your B.C. assessment. How, because in 2010, the appraisal report calculated your condo to be valued at $312,000, but a buyer is offering fair market value of $310,000.
Capital loss = $312,000 – $310,000 = –$2,000
This capital loss of $2,000 can be deducted from the capital gains when you go to sell, or for any of the years prior to the sale date (when you would have to pay tax on the capital gains).
From these calculations, you would not owe capital gains tax on the sale of your property. However, please note that we have only briefly summarized some of the tax rules regarding capital gains and property. A comprehensive analysis may be applicable for a complete picture or for other situations. In this case, it may be wise to discuss the situation with a qualified tax advisor.
George E. Dube, CPA, CA is a veteran real estate investor and accountant. He is a speaker who has written various articles and co-authored two books on real estate accounting. He can be reached at: firstname.lastname@example.org or follow him on Twitter at @georgeEdube.