Real Estate Gains and Canadian Income Tax – A Brief Analysis

A Brief Analysis of Real Estate Gains & Canadian Income Tax

Recently there has been a lot of media attention focused on financial gains being made in Vancouver’s housing market and the favorable tax treatment given to real estate used as a principal residence through the Canadian Income Tax Act. Without getting into the technical details of this tax treatment and all of the possible complex scenarios, the simple rule is that as long as a taxpayer or an immediate family member ordinarily lived in a residence every year of ownership, that residence would qualify for the full principal residence capital gains exemption upon sale.

Exceptions that CRA may scrutinize

Needless to say, there are many exceptions that would disqualify a taxpayer from the full principal residence exemption. Due to the size of this tax exemption, taxpayers should be aware of the relevant tax rules so that they stay on the right side of the law. CRA is aware that real estate gains are being realized all across Canada so this could potentially be an area that CRA may scrutinize closely in the near future.

Possible disqualifications

Here is a list of scenarios where the principal residence exemption could be denied or scrutinized by the CRA:

  1. Claiming capital cost allowance (CCA) on the part of the principal residence being rented to a third party would deny the taxpayer the principal residence exemption altogether.
  2. If you are buying land you intend to build a residence on in order to live in it and then you’re selling it shortly after the construction for a gain and you repeat this pattern frequently, the CRA can deem the gain as business income and not a capital gain. The principal residence exemption is intended to shelter the capital gain generated from the sale of the residence; it does not shelter business income. This is especially true if the taxpayer works in the real estate industry such as a realtor, architect or a builder – in these cases the CRA can argue that the gain from sale of the residence is not on account of capital but on account of conducting regular business.
  3. If more than 50% of the principal residence has been used to generate rental income during the period of ownership, that portion of the residence is not considered principal residence and hence no exemption would apply on that portion.
  4. If the owner rented the entire residence for more than four years (i.e. the taxpayer or a family member did not reside in the residence at any time during the four years), the full gain on the sale of the residence may not be exempt.
  5. If the taxpayer was a non-resident for any year during the period of residence ownership, the full gain on the sale of the residence may not be exempt.

Above examples are just a handful of the many scenarios that can jeopardize the full gain from being exempted. Since capital gains are very material, it is wise to consult a professional tax advisor to ensure the gain satisfies the criteria for the full principal residence exemption.

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