Your principal residence and taxes.

• Author: Neilson, Hugh
• Position: Feature: Real Estate Law

Capital gains have been subject to taxation in Canada since 1972. At present, only half of any capital gain is included in income.

While this includes property such as real estate, most Canadians are aware that there is a "principal residence exemption", and believe gains on their home will not be taxable. For the average Canadian family, which owns and resides in a single residence at a time, this is the usual result. However, the rules can become complex in many situations, sometimes catching taxpayers by surprise.

The Basics

Every Canadian resident is entitled to designate a property they "ordinarily inhabit" during the year (more on this later) as their "principal residence" for each calendar year. Since 1981, families (spouses, including common law partners, and their minor children) can designate only one property between them. Provided the property sold is designated for at least one year, a portion of the gain is exempt, computed as 1 + the number of years designated/total years owned. Years prior to 1972 are ignored in the computation.

So, when a family sells one residence and acquires a new one, they can designate the property sold as their principal residence for all years prior to the year of sale, and the entire gain will be exempt from taxation. This "1+" rule ensures a family can own two residences in the year they move without jeopardizing the tax-free status of their homes. Although the legislation requires a form (T2091) be filed to designate a property as a principal residence, the Canada Revenue Agency (CRA) has consistently maintained a policy that this form need not be filed if no portion of the gains is taxable.

Home, Sweet Home(s)--Multiple Residences

The term "ordinarily inhabited" is not defined in the legislation. However, as a property can be ordinarily inhabited at any time in the year, it is not necessary that the property be the family's main home. A summer cottage or other recreational property might be inhabited for only a week or two, but this is sufficient to allow it to be designated. A property may qualify by being ordinarily inhabited by the individual, their spouse or common-law partner, or any of their children.

For families with multiple residences, such as recreational properties, or parents who own properties occupied by their children, a choice must be made about which property to designate. For example, assume Bob and Mary own a house in the city which they purchased in 1994 for $250,000. The...