Principal Residence Exemption – Overview
Canadian residents who dispose of their family home and realize a gain may claim an exemption when computing the tax on that gain. The exemption will eliminate all or part of the taxable capital gain, depending on the circumstances. This is the “principal residence exemption” (PRE).
To qualify for the PRE, an individual must own the property as capital property (i.e. no intention to sell the property) and that individual or their spouse or child must “ordinarily inhabit” it in each year for which the exemption is claimed.
Where, at the time of purchase/development, the taxpayer has an intention to sell the property, the property is held on account of income and the full amount of any gain is taxed at regular income rates (53.53%). It can be difficult for both the CRA and the taxpayer to demonstrate intention as it is largely a subjective determination.
New “Anti-Flipping” Rule
In an attempt to remove the subjectivity in determining whether a property is held on income or capital account, the 2022 Federal Budget proposed a new bright-line test to deem profits arising from dispositions (after January 1, 2023) of residential property (including a rental property) that has been owned for less than 12 months to be business income (53.53% at the highest rate), and therefore not eligible for the principal residence exemption. The new 12-month holding period creates a definitive timeline that must be met.
The new deeming rule will not apply where one of the following “life events” has occurred:
- Death: a disposition due to, or in anticipation of, the death of the taxpayer or a related person.
- Household addition: a disposition due to, or in anticipation of, a related person joining the taxpayer’s household or the taxpayer joining a related person’s household (e.g., birth of a child, adoption, care of an elderly parent).
- Separation: a disposition due to the breakdown of a marriage or common-law partnership, where the taxpayer has been living separate and apart from their spouse or common-law partner because of a breakdown in the relationship for a period of at least 90 days.
- Personal safety: a disposition due to a threat to the personal safety of the taxpayer or a related person, such as the threat of domestic violence.
- Disability or illness: a disposition due to a taxpayer or a related person suffering from a serious disability or illness.
- Employment change: a disposition for the taxpayer or their spouse or common-law partner to work at a new location or due to an involuntary termination of employment. In the case of work at a new location, the taxpayer’s new home must be at least 40 kilometres closer to the new work location.
- Insolvency: a disposition due to insolvency or to avoid insolvency (i.e., due to an accumulation of debts).
- Involuntary disposition: a disposition against someone’s will, for example, due to, expropriation or the destruction or condemnation of the taxpayer’s residence due to a natural or man-made disaster.
In circumstances where the new deeming rule does not apply, either because of a life event listed above or because the property was owned for 12 months or more, it remains a question of fact whether any gain from the disposition of the property would be on account of capital or income. In other words, just because the deeming rule does not apply does not guarantee that the principal residence exemption will be available.