Tax changes that were aimed primarily at foreign investors in Canadian real estate to ensure they abide by existing tax rules, are set to have an additional impact on Canadian homeowners, according to a Toronto-based tax expert.
Canadian’s Finance Minister Bill Morneau introduced changes last week will require property owners in Canada to report every sale of a principal residence on their tax return, whether they owe tax or not. But, according to a report in Toronto local newspaper The Globe and Mail, the rules might also catch many Canadian residents who, in the past, have often inadvertently escaped paying tax on their principal residences.
Tim Cestnick, of fee-based financial adviser WaterStreet Family Offices in Toronto, said that the tax rules around principal residences are so complex that many Canadians simply don’t recognise when they might owe tax when they sell a property.
“Many have assumed that every sale of a residence is always tax-free thanks to the principal-residence exemption (PRE),” said Cestnick. “And the taxman has not required Canadians to report the sale of a principal residence if the PRE will shelter the full gain from tax. The result has been that many have sold residences, have not reported the sale, have paid no tax, even in situations where tax should have been owing. These dispositions have gone largely undetected by the taxman.”
Example of sale
Cestnick cites an example of a homeowner that say, purchased a home in the year 2000. In 2004, he purchased a cottage. In 2010, he sold his city home for a profit and purchased a new one. Then, in 2014, he sold the cottage for a profit.
“If he didn’t report the sale of the city home in 2010 because the PRE sheltered the full capital gain from tax then no problem,” he says. “Nor did he report the sale of his cottage in 2014 because he correctly understood that a cottage can also generally qualify as a principal residence. The problem? He believed the cottage sale was also tax-free, thanks to the PRE – but it wasn’t.”
Cestnick points that that homeowner was entitled to designate his city home as his principal residence for each year he owned it. Since he didn’t file Form T2091 (the form used to designate a property as your principal residence) and report the sale on his tax return, the CRA deems him to have designated the city home as his principal residence for all the years he owned it, with the result being that no tax was owed.
“As for the cottage, he was not entitled to designate it as his principal residence for the years 2004 to 2010, because those years were already spoken for. He had already “used up” those years on his city home. The result is that part of the gain on his cottage is taxable. He was required to file Form T2091 and report the cottage sale on Schedule 3 of his tax return. He should have paid some tax,” he said.
As the example proves, points Cestnick, many Canadians don’t understand how these rules work and have inadvertently, in the past, escaped tax on the sale of all properties they might have owned. Under the new rules, the CRA will have the information it needs to figure out whether tax might be owing.
Canadian property owner implications
“The new rules will require you to report every sale of a principal residence on your tax return, whether you owe tax or not,” says Cestnick. “And this starts with dispositions in 2016. So, if you sold a home earlier this year, you’ll have to provide basic information (date of purchase, proceeds of disposition and a description of the property) on Schedule 3 when you file your 2016 tax return.
“If you fail to report the sale of a residence in 2016 or later years, you won’t be entitled to the PRE. If you forget to designate a property as your principal residence in the year of sale (for 2016 and later years), you should ask CRA to amend your tax return for that year,” he adds.