How do you declare your principal residence exemption?
Q: My husband and I just sold our family home. We have two young children and won’t be purchasing another home at this time. Instead, we’ll spend the next six months evaluating our options.
The home we sold was our principle residence. We purchased this home 15 years ago for $182,500. We just sold it for $402,000. Do we have to pay capital gains tax on the profit of the sale of our home? If we don’t have to pay capital gains tax, do we still have to claim the money as income on our income tax return?
Finally, what’s the best way of dealing with the remainder of the money so that it can be used as a down payment for our next home, when we are ready to buy?
—Teri Lynn Mucin, via Facebook message
Answer from Romana King, senior editor and real estate specialist at MoneySense:
Teri, you and your husband will be happy to learn that you will not owe a single dime in taxes even though you’re seeing a net profit from the sale of your family home. That’s because the Canada Revenue Agency (CRA) provides Canadian homeowners with an exemption from taxes owed on the profit made from the sale of your principal residence.
To understand why, let’s take a step back.
All property—and this includes your home, cottage, rental units, even stock portfolios—can rise in value over time. This increase in value is known as a capital gain (in stocks, there are other forms of earnings, but that’s not the subject of this post). In the eyes of the CRA, a capital gain is subject to tax, known as a capital gains tax. The capital gains tax is based on your marginal tax rate and is charged on only half of the profit earned from selling the property. So, if you sold an Ontario property and earned $60,000 profit on the sale, and you earn $30,000 in income per year, you would pay 10.03% on that capital gain—so, approximately $3,000 in taxes would be owed to the CRA.
But there are legal exemptions. For property, the CRA provides a capital gains tax exemption on a family’s primary residence. That means you don’t have to pay any tax if you end up earning a profit on the sale of your family home.
The CRA is pretty clear on what can be designated a primary residence: A primary residence can be a cottage, trailer, detached home or condo. Keep in mind only one primary residence can be claimed by a family unit (meaning your spouse or any child under 18 can’t claim a different primary residence). You can only claim one home as a primary residence in a given calendar year. (There are mathematical nuances to this rule, but for now, just assume that one house per year can be designated a primary residence.) Finally, you don’t need to sell a property to realize a capital gain (and exemption).
Whenever you sell a primary residence the CRA does not require you to report this sale on your income tax return—even if you make a profit. But that changes as soon as you change the use of the home. So, if you rented out a portion of your home, at any time, you would need to report the sale of the house and then work out what portion is exempt from capital gains tax and what portion is not. (Read more, re.)
Now, as to what you should do with the profit from the sale of your home. The best answer really depends on your circumstances. Will you try and buy within the next three years? If so, then your investment horizon is quite short and this means your primary goal for this money would be to protect it from market fluctuations. To do this you need to put the money in relatively risk-free investment, such as a GIC, a high-interest savings account or in a money-market fund (search our moneysense.ca site using either one of these search terms and you should find great tips).
You may also want to take a portion of the profit and contribute to both your TFSA and your husband’s TFSA. Any interest or income earned in a TFSA is tax-free. This means that when you take the money out, you won’t be taxed on any revenue earned during the time it was invested. For example, take $80,000 and open up two Zag Bank high interest savings TFSAs, which pays 2.50% on your investment, and put half of the money into each account. In three years you could withdraw the initial $80,000 you’d invested into each account, as well as the tax-free earnings of $6,230 that you’d earned on that invested money.
I hope this helps, but please be aware that I’m not an accountant or a legal professional. For specific advice, please seek out the advice of a professional for each particular situation.