What is Principal Residence Exemption?
Principal residence exemption (PPE) provides a way for Canadians to claim exemption from paying capital gains tax on sale of residence. Taxpayer can claim this exemption provided they have designated their residence as their principal residence.
What is Principal Residence?
It can be defined as a home that a Canadian taxpayer has designated as their main residence, meaning that it is inhabited as taxpayer’s residence. An important note to remember is that only one residence can be the main residence, so if a taxpayer owns multiple properties only one property can be the main residence.
How is Principal Residence Exemption calculated?
If the taxpayer owns only one property then PPE is simply claiming exemption on the sale of the property in question. However, if the taxpayer own’s multiple properties then PPE needs to be carefully planned.
Ideally, a taxpayer should claim PPE on a property with higher capital gains as you want to minimize tax. Therefore, if there are multiple properties then the taxpayer has to carefully consider which property to claim PPE. Once an exemption is claimed for specified years then it cannot be claimed again for another property.
CRA does not specify a specific duration that you have to occupy a property to claim PPE on it. However, CRA will verify if there are any indications of tax avoidance through PPE>
Let’s say a taxpayer has two properties bought at the same time and decides to sell one property claiming the exemption. If the second property is sold later, PPE cannot be claimed for the years already claimed for the first property.
If the second property had higher capital gains than the first property the taxpayer will end up paying higher tax.
A point to note is that if spouses are living together then they cannot claim PPE on two different properties.
Be careful of claiming PPE when flipping houses as this is considered commercial activity and does not qualify for PPE. Even if you live in the house for a short time before selling it, it is still considered commercial activity. The intent matters here as in this case it was always to flip the house after renovating it, CRA will be looking at the pattern of buying and selling houses.
Claiming PPE on rental property
PPE cannot be claimed on a rental property as it is not the main residence of the taxpayer. If the owner of the rental property decides to live in the property before selling it then there is the issue of change in use of the property.
If the use of the property is changed from rental to residence then the property is deemed to be sold a fair market value and immediately bought by the owner. This has tax implications for the owner and needs to be considered carefully, ideally discussing with a professional financial planner.
Disclaimer: Information provided may not be complete or accurate. It should not be considered financial advice.