15 What is the Principal Residence Exemption? How does it impact Taxable Income and what are the basics of the calculation?

The principal residence exemption (“PRE”) is an income tax benefit that can reduce or eliminate tax on capital gains realized when you sell your principal residence.    The PRE is only available on one property per family unit (this includes your spouse and unmarried children)  and, to be designated as a principal residence, your property must be ‘ordinarily inhabited’ during the year. ‘Ordinarily inhabited’ is not defined in the ITA but Income Tax Folio S1-F3-C2 states that it can apply “even if a person inhabits a housing unit only for a short period of time in the year.”

The PRE represents a potentially huge tax benefit for homeowners in Canada.

Basics of Calculation: A- (A x {B/C})-D

where

A is the individual’s total capital gain on the disposition of the principal residence;

B is one plus the number of years the property was designated as the individual’s principal residence (and during which the individual was resident in Canada);

C is the number of taxation year-ends that the individual has owned the property (this includes the year of purchase and the year of sale); and

D is a specific rule related to certain houses purchased prior to February 23rd, 1994 and won’t be considered for this course.

Example: In 2002, Mr. An acquired vacant land for $50,000. In 2005, he constructed a housing unit on the land, costing $200,000, and started to ordinarily inhabit the housing unit. In 2011, he disposed of the property for $300,000. Calculate exemption amount, TCG.

Solution:

A- $300,000-($200,000+$50,000) =$50,000 (assuming there was no cost of disposition);

B- 7+1=8 (Principal Residence for 2005-2011; 2002-2004 excluded because no one lived there);

C– 10 (tax year-ends from 2002-2011);

D- 0

• A – {A(B/C)}-D = $50,000- {$50,000*((7+1)/10)}-0 = $10,000 Capital Gain.

TCG ($10,000 * 50%) = $5,000 Taxable Capital Gain

Tax planning:  For family units that have two or more properties eligible for the PRE, typically you would apply the PRE to the property with the highest capital gain per year to fully eliminate that capital gain.  Any remaining years would then be applied to the other property.

Interactive content (Author: Angel Mo, January 2020)

References and Resources:

• Article – Income tax folio S1-F3-C2, Principal Residence (Author: Government of Canada)
• ITA- 40(2)(b), 54, 110.6(19), 110.6(21).

January 2020