Canadians can claim the principal residence exemption (PRE) on the sale of a home. But there are misconceptions about how the PRE works if you’re selling at a loss, or you’re renting out your home to work remotely elsewhere. Kim Parlee talks with Georgia Swan, Tax and Estate Planner, TD Wealth.
Print Transcript
Most Canadians know that when they sell their home, the principal residence exemption exempts the homeowner from paying any taxes on the gains. But my guest says if you're selling your home at a loss or if you're renting out your home to work remotely elsewhere, you better know the ins and outs of the personal residence exemption, or it could cost you. Joining me now is Georgia Swan, tax estate planner with TD Wealth. You're nodding because that's what you told me, and I know you agree with this stuff. People need to understand it. Georgia, listen, let's just start with the basics. Just explain how the principal residence exemption works. So if you ask a lot of people about selling their principal residence, most people think that there's no capital gains on it, or there might be capital gains, but it's not taxed. And in actual fact, when you're thinking about the principal residence exemption, you've got to flip the script. Basically, you should think that there is always tax on all capital gains, even on a principal residence. But the exemption is basically a formula where if your home qualifies as a principal residence and the variables that you fit into that formula work out right, it will calculate the amount of capital gain that you can shelter by the exemption. So just from that statement, there are so many variables and complexities. Does it qualify as a principal residence? What are you plugging into that formula? And people should never think that it's automatic that the entire gain is going to be sheltered by the exemption. I have never had it explained that way before, so I hear you. I got it this time. And that's good. So you need to designate a property first as a principal residence. What do you need to think about? Well, first of all, I think years ago, people were used to selling their principal residence and just basically not having to report anything. But since the 2016 taxation year, you actually have to report the capital gain on what's known as schedule 3 of an individual tax return, and then you also have to file an additional form in which you actually-- or on which you designate the particular property as your principal residence. That form is T2091. And there can be a lot-- there can be consequences for basically not filing that form, which include penalties up to $8,000, depending on how late the form is. The CRA can deny the principal residence exemption on the capital gain and may make you pay tax. You could also end up, basically, getting audited as a result of that. So none of those outcomes are probably welcome to anyone. So it's really important if you sell a home that you think is your principal residence-- make sure you get good advice. So Georgia, then, I think people-- maybe they know if they watch this program, but what you choose to have as your principal residence could be where you live most of the time, or it could be a cottage, or it could even be outside of Canada if it qualifies. Yes, that's correct. So the definition of a principal residence is any dwelling unit, so a house-- it could even be a houseboat-- whether it's in Canada or outside of Canada that you ordinarily reside. An ordinary residence could be something as short as a couple of weeks out of the year. Where things get complicated, though, is if you also rent out a portion of the property. That can create problems for being able to shelter the capital gain using the exemption. And a lot of people are doing that right now, right? You think of it-- or a lot of people have during COVID. They've gone somewhere else. They've rented out their home. And they might have a bit of a rude awakening in terms of what qualifies. That's entirely correct as well. Basically, you have to consider, is it a long-term rental? I mean, if you're going away for two weeks on vacation and you post your home on a short-term rental site, that's OK. But if you're basically predominantly renting the house, either long-term or short-term rental, that can cause problems and disallow the exemption. So you have to be very careful about those types of activities as well if you run a business from the house. If there's other activities, it is very important to get proper advice about the exemption. And just something for people to keep in mind-- I mean, I know this will depend on the situation specifically, and people do need to talk to somebody. But when you say predominantly, is it as simple as more than 50%, or is much more nuanced than that? It's a lot more nuanced than that. There's all sorts of case law about what constitutes it. And you also have to be careful because the CRA is really looking at these transactions very closely now because there's a lot of people that have been abusing the exemption. You have serial renovators that buy a house, renovate it while they're living there, and then sell it. And the CRA is looking very closely at these types of transactions because they're trying to crack down on the misuse of the exemption. Yeah. What about-- and this is something that is probably new because housing prices have been going up forever, so we're used to that. Now we're actually starting to see some softening in certain markets right now. So some people might have bought at a high, and now maybe decide they can't afford it with rates going up, and they're looking to sell, maybe at a loss. What do they need to keep in mind with the principal residence exemption? So in that case, people might be used to the fact that capital losses can usually be applied against capital gains in the future back three years. But when it comes to a capital loss from a principal residence, that doesn't happen. Basically, because the principal residence is considered personal property, a loss from the sale of a principal residence is basically a loss. You don't get to apply it anywhere. So it can be pretty devastating to people because that's just money straight out of their pocket. Last question for you, Georgia. Is there anything else people should be thinking about when it comes to the principal residence exemption and their ways that maybe they're misusing it? So people should realize that it is more complicated than they think. If you are running a business from your property, if your property is exceptionally large-- because there are limitations on the amount of land around the property that can be exempted by the exemption-- if you're using it for purposes that it wasn't intended-- so if it is a situation where you're buying properties and then selling them soon thereafter, you can end up on the CRA's radar. So you really should be talking to the right professionals to make sure that you're using the exemption properly and you're getting the right guidance about it. That's why we turn to you to talk about these things, Georgia. Always a pleasure. Thanks so much for joining us. Thanks so much, Kim. Good to see you again. [AUDIO LOGO]
[MUSIC PLAYING]
[MUSIC PLAYING]