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Impact of New Principal Residence Exemption Rules on Non-Residents Purchasing Canadian Real Estate

On October 3, 2016, the Canadian Department of Finance introduced some significant changes to the principal residence exemption (PRE) rules. The Department of Finance stated that the purpose of these changes was to improve tax fairness by preventing perceived inequities connected to the capital gains exemption on the sale of a principal residence.

The main change to the PRE rules will limit the ability of certain taxpayers to reduce or eliminate the capital gain on the sale of their home.

A principal residence of a taxpayer means a property which the taxpayer (including their spouse or common-law partner or child) has “ordinarily inhabited.” The amount of the exemption available to a taxpayer is determined by a formula that prorates the amount of gain by the number of years in which the property was designated as the taxpayer’s principal residence (the numerator) compared to the total number of years that the taxpayer owned the property (the denominator).

While the PRE rules only allow one property to be designated as a taxpayer’s principal residence for a particular tax year, the PRE rules recognize that a taxpayer can have two residences in the same year. This often happens when one residence is sold and another is bought in the same year. In such cases, the formula adds one year (the “one-plus rule”) to the designated principal residence years (the numerator) to allow both properties to be treated as a principal residence for the one year that both are owned.

The one-plus rule will apply after October 3, 2016 only when the taxpayer is a resident in Canada during the year in which the taxpayer acquired the property. Thus, an individual who was not a resident of Canada in the year they acquired the residence will not be able to add the additional year to the designated principal residence years in the year of sale for sales after October 2, 2016. This measure has been put in place to ensure that permanent non-residents are not eligible for the PRE on any part of the gain from the sale of a residence. However, it appears that the PRE rules do not provide relief to a non-resident taxpayer who acquires a residence and then immigrates to Canada in a subsequent year and resides in that property. Furthermore, the rules do not penalize a taxpayer who emigrates from Canada and continues to own the property that was acquired while being a resident of Canada.

Reporting Requirements for Sales of Principal Residences

The new PRE rules will apply to taxation years ending after October 2, 2016. Accordingly, starting with the 2016 taxation year, vendors who sell their principal residence including deemed dispositions on or after January 1, 2016 are now required to report the sale on their income tax return and make an appropriate principal residence designation to claim their PRE on their 2016 return.

This rule replaces Canada Revenue Agency’s (CRA) administrative policy which stated that an individual is not required to report of the sale their residence nor file the Form T2091 when the PRE eliminates the entire taxable gain.

Penalties Relating to the Reporting Requirements

Finally, when the sale of a home has been reported but a principal residence designation was not made in the taxpayer’s tax return, the CRA will be able to accept a late-filed principal residence designation subject to a penalty of $100 per month to a maximum $8,000.

Under normal circumstances, CRA may only assess tax paid by a taxpayer for a taxation year during the “normal reassessment period”. The normal reassessment period for individuals is three years from the date of the original notice of assessment issued by CRA. However, the PRE rules indicate that CRA has now the ability to reassess tax beyond the normal reassessment period if the taxpayer does not report a disposition of a real estate property on the appropriate tax return. This change is much broader since it applies to all unreported disposition of a real estate property and not just the disposition of a principal residence.

This reassessment beyond the normal reassessment period would only be limited to the unreported disposition of a real estate property. If the return is amended to include a previously unreported disposition of a real estate property, then the normal reassessment period for that disposition would begin on the date of the notice of reassessment issued by CRA.

The two major changes to the PRE rules that affect non-residents will be the loss of the one-plus year plus rule for non-residents acquiring a principal residence and the requirement to report the disposition of a principal residence. These changes were brought about by concerns with maintaining the stability in the Canadian housing markets. Furthermore, the Department of Finance has stated that they wish to have a tax system that is not only fair, but is perceived by taxpayers to be fair, thus, they want the PRE to be only available where appropriate. Furthermore, earlier in the year the British Columbia Ministry of Finance placed an additional property transfer tax on residential property transfers to foreign entities in the Greater Vancouver Regional District.

This article can be seen in Global Tax Insights, Morison Global’s quarterly tax newsletter. Visit Morison Global to view the complete newsletter.

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