Starting January 1, 2023, the Canada Revenue Agency (CRA) has introduced new rules impacting the sale of housing units held for less than 365 consecutive days. Under these changes, any gain from the sale of such property is now considered business income rather than a capital gain, unless the property is classified as inventory or the sale results from specific life events. This blog explores these changes, what qualifies as a life event, and their implications for homeowners and investors.
What is Business Income vs. Capital Gain?
Previously, when a property was sold in Canada, the gain was typically treated as a capital gain, subject to a 50% inclusion rate for taxation. However, with the new rules, if you sell a housing unit or a right to acquire such a unit within 365 days of owning it, the entire gain may be considered business income and taxed at 100%, unless the sale occurred due to certain life events.
Exceptions to the 365-Day Rule
Certain life events allow for the gain to continue being taxed as a capital gain rather than business income. These events include:
- Death of the taxpayer or a related person.
- A related person joining the taxpayer’s household or the taxpayer joining theirs (e.g., moving in with a spouse, birth or adoption of a child, or caring for an elderly parent).
- Breakdown of a marriage or common-law partnership, where the taxpayer has been living separate from their spouse for at least 90 days.
- A threat to personal safety, such as domestic violence.
- A serious disability or illness affecting the taxpayer or a related person.
- Eligible relocation of at least 40 kilometers closer to a new work or school location.
- Involuntary termination of employment for the taxpayer or their spouse.
- Insolvency of the taxpayer.
- Destruction or expropriation of the property (due to natural disasters, for example).
Reporting the Sale of Your Principal Residence
Since 2016, the CRA requires taxpayers to report the sale of their principal residence and designate it as such on their income tax return. If you forget to make this designation, it’s crucial to amend your tax return. Late designations may be accepted, but penalties could apply. If the home wasn’t your principal residence for the entire period you owned it, you will need to report the capital gain for the years it was not designated as such.
How to Report a Partial Capital Gain
If your home was only your principal residence for part of the time you owned it, you need to calculate the capital gain related to the non-designated years. This can be done by completing Form T2091(IND).
Owning Two Residences in the Same Year
It’s possible to designate two properties as your principal residence in a single tax year, provided you sell one and acquire another in the same year. The “one-plus” rule allows you to treat both properties as a principal residence during that transition year, even though only one can be officially designated.
Constructing a Home on Vacant Land
If you buy vacant land and later build a home on it, the property may only be designated as your principal residence starting the year you, your spouse, or child begins living there. The years during which the property was vacant land or under construction will not count toward the principal residence exemption. Let’s look at an example to illustrate this.
Example: Disposition of a Housing Unit Constructed on Vacant Land
In 2002, Mr. A purchased vacant land for $50,000. He constructed a housing unit on the land in 2005, which cost $200,000. Mr. A began living there the same year and eventually sold the property in 2011 for $300,000. His gain on the sale is calculated as $300,000 (sale price) minus $250,000 (adjusted cost base) = $50,000.
Mr. A can designate the property as his principal residence from 2005 to 2011 (the years he lived in the house). However, the years 2002 to 2004, when the land was vacant or under construction, cannot be designated. Let’s apply the CRA’s principal residence formula:
Principal Residence Exemption Formula:
A×(B÷C)A \times (B ÷ C)A×(B÷C) Where:
- A is the gain otherwise determined ($50,000)
- B is the number of years the property was the principal residence (1 + 7 = 8 years)
- C is the total number of years Mr. A owned the property (10 years)
The formula:
50,000×(8÷10)=40,00050,000 \times (8 ÷ 10) = 40,00050,000×(8÷10)=40,000
Therefore, $40,000 of Mr. A’s gain can be sheltered by the principal residence exemption, leaving $10,000 subject to tax.