When can selling a property lead to a capital gain?


When you own more than one property, you must designate one of them as your principal residence in order to take advantage of the exemption.

Financial analysis provided by Angela Iermieri | Financial planner | Desjardins Group

Linda and Carl* have just retired, and have all kinds of plans. For one thing, they want to sell their principal residence and move to the country. They're wondering about the tax implications of their plan.

Financial profile 
Linda and Carl, age 55, retired
They own:
  • A principal residence
  • 36 hectares of land
  • A rental condo
Their game plan
  1. In 1 year: Build a new home on their land.
  2. In 2 years: Sell their principal residence and move to their country house, which will become their new principal residence.
  3. In several years: Sell their country house and live in a condo, which will become their principal residence until they can't live there anymore.
  4. Sell the condo.
Tax strategy 
Can you rotate which property you declare as your principal residence to avoid paying tax on the capital gain? 

Angela Iermieri, financial planner at Desjardins Wealth Management answers.

The facts
When you own more than one property, you must designate one of them as your principal residence in order to take advantage of the exemption. The designation is made when you sell the property, on the tax return for the year of the sale. Even if you only live there for a short time during the year, the property can still be considered "ordinarily inhabited" and therefore be deemed your principal residence. 

A principal residence is a real estate asset that is: 
  • Designated as your principal residence for a given year. By law, Canadian residents can only designate one principal residence per couple, per year. 
  • Owned by you, either solely or jointly, during the year of designation.
  • Occupied by you, your spouse or your child at some time during the year. 
  • Located in or outside Canada. 
  • A house, condominium, cottage or apartment building unit. 
  • Situated on up to 1/2 hectare of land (around 50,000 ft2 or 5,000 m2).
When choosing which home to designate as your principal residence, it's important to consider the capital gain on the other properties so you can choose the most tax-effective option. 

What this means for Linda and Carl

Step 1: Designate the family home as their principal residence 
The couple will have to declare their home as the principal residence for each year they live there if no other property meets the designation criteria.  This would be the case if, when they sell their principal residence: 

  • They have never lived in the home they built on the land and
  • They are still renting out the condo.
Step 2: Designate the country house as their principal residence
Once they move to the country, the country house can be recognized as the principal residence for each year the couple lives there. 

However, given the size of the land, certain restrictions will apply. 

When they sell the property, the principal residence exemption will only apply to the house plus 1/2 hectare of land. That means the remaining 35 1/2 hectares will be excluded and therefore subject to any capital gains tax.
 
Step 3: Designate the condo as their principal residence
Like the country house, the condo can be designated as the principal residence for each year Linda and Carl live there. 

Since the condo hasn't always been their principal residence, they will be taxed for the years they rented it out. 

Principal residence exemption scenario: 
The couple bought the condo for rental purposes in 2011 for $175,000.
In 2025, they stop renting it out and make it their principal residence. 
After 5 years (in 2030), they sell the condo for $300,000.
The capital gain on the sale, i.e., the difference between the price they paid for the condo and the price they sold it for (including selling costs), is $125,000.

Theoretical calculation of principal residence exemption

Capital gain
x
1 + number of years the property is designated as the principal residence*
÷
Number of years the person has owned the property*
=
Tax exemption

Linda and Carl's calculation
$125,000 
7 years
÷
 20 years
 = 
$43,750

When the condo is sold, the $43,750 exemption will be deducted from the capital gain. The gain to be reported would therefore be $81,250 ($125,000 - $43,750).

50% of the realized capital gain is taxable, so the couple will have to pay tax on $40,625 ($81, 250 x 50%). 

How to reduce a hefty tax bill
At the time of the sale, there are two options:

1. Max out your RRSP 
If you have contribution room available, contributing to an RRSP can reduce the impact of the capital gain. If you're over 71 and have a younger spouse, your contribution room can be used to contribute to your spouse's RRSP.

2. Use prior capital losses
Since capital losses can be carried forward, prior capital losses can be used to reduce your capital gain when you sell your property.

Editor's note: These are ideas to help Linda and Carl achieve their goals. For personalized advice on how to achieve your own financial goals, contact an advisor today.

* You only need to own the property at some time during the calendar year to include that year in the calculation.

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