The principal residence exemption: the biggest asset you don’t know you have

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- For most Canadians, your home is likely your biggest investment. And real estate prices in most parts of the country have done very well, and you could be sitting on a tidy profit when it comes time to sell. My guest says that's why you need to know how to take advantage and not run afoul of your principal residence exemption. I talked with Chris Gandhu-- he's a High Net Worth Planner at TD Wealth-- about that, and here's what he had to say.

- So if you're a Canadian that owns a home, maybe in Toronto, Vancouver, or Victoria-- the high growth markets-- this is a fantastic way to save you some money when you have to sell the property. And it's an extremely flexible option, so make sure you understand it and use it appropriately.

- OK. Let's talk about the flexibility. How is it flexible?

- I mean, typically you'd think, well, I live in this house. This must be my principal residence exemption. But the way the legislation works, the house is defined very differently. It could be a home. It could be a condominium. It could be a cottage. It could be a mobile home. In fact, it could be a vacation property outside Canada. Even that may qualify, and a lot of people miss that.

- Can you walk us through how it's commonly used?

- Right. So again, typically a Canadian may say, well, I have to live in that house for it to qualify. But again, that's not necessarily true. The phrase used in legislation is, it has to be ordinarily inhabited. Well, what does that mean? It doesn't mean you have to live in that house full-time. It doesn't even mean you have to live in that house most of the time.

If you aren't renting the house, so there's no other use, but you use it some of the time, that will help you qualify. In fact, you don't even have to live in the house. Sometimes your spouse or your children that may use the property could also qualify it for you.

- It's interesting as well because I know from when we've spoken, you've said that you have the option of electing which house you want to use. Let's say if you had two properties, I know the example you like to use is someone lives in Halifax and they have a cottage in Florida. What kind of options do they have available to them?

Right. So let's imagine this person wants to go into retirement, move into a retirement home, and sell both houses. Again, the typical reaction would be, well, my Halifax home, my Canadian house-- I'll use the principal residence exemption and shelter the gain on it, and I'll pay any tax I owe on the Florida property. But that is not the only option.

Depending on what's beneficial, they could choose the Florida property to be the principal residence exemption or vice-versa.

- So I think that the principal residence exemption is something we always hear about, but I don't think people understand really, how is it commonly used?

- I'll give you my example. So we moved residences a couple of years ago. So at that point, I had to make a choice. Do I pay the tax on the first property that I just sold, on the gain, or do I designate it as my principal residence and claim the exemption? And that's what we find with most Canadians is when they're moving from residence A to B, if they're triggering a gain, they can use the principal residence exemption.

- What about other types of flexibility if, let's say, I decided that I had to make ends meet and I need to rent out a part of my home while I live there. Does that jeopardize the principal residence exemption?

- Right. So it may. The question is going to be, once you start renting out that property, does the whole property qualify for the principal residence exemption or not? And CRA has some very clear guidelines on this. If the income that you're earning is ancillary-- so perhaps if you only rent it out once in a while, as opposed to renting it out full-time-- that goes in your favor.

If you didn't have to do any major renos-- so if it's a basement that you put a new kitchen in it, probably means the basement is not going to qualify for the PRE, but the rest of the house may. If you're taking any amortization expenses and claiming them on your tax return, clearly you can't double dip. That may preclude you from qualifying for the PRE.

- So it sounds as if something like Airbnb would be a little more acceptable, perhaps, to CRA than would be if you're going to permanently rent out part of your house.

CHRIS GANDHU: That's a great example. That's right.

- Yeah. What about if you're traveling for longer and want to rent out your property? Let's say I've got a sabbatical, and I'm going to head overseas somewhere for a year, and I want to rent my house for a year. What happens then?

- So there's a lot of nuances around that because there's a change of use you've had. It used to be a residence that you used to live in, and now you're renting it. And you have an option here now. You could either pay tax on the gains, or you could claim your principal residence exemption, or you could make a further election and not decide right now and choose to defer the tax until a later year. So you do have some options.

If you become a non-resident of Canada, though, that house, even if you maintain it, no longer qualifies as your principal residence, so any appreciation after the fact when you left Canada will not be sheltered by the exemption.

- And so what else do we need to do? Other things we need to think about?

- So what we've talked about, in fact, is just the tip of the iceberg. There are a lot of nuances around this. What if you live outside the city and have an acreage? Well, does the land surrounding your house qualify for the principal residence exemption? What if you choose to travel and when you do that, you rent out your property? Now what happens? Are you triggering the gain and must you pay tax on the way out?

What if you go for work outside of Canada, but you maintain the property in Canada. During the interim, it's property which is appreciating. Is it still qualifying as a principal residence? So there's a lot to think about. Don't take this lightly. Talk to a professional.

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