Selling Property in Ontario – Reviewing the Principal Residence Exemption and Property Flipping Rules
The sale of any residential property in Canada generally triggers a capital gain which means that 50% of the increased value of the property is taxable on sale. For example, if one purchased a property for $100,000 and sold the property for $150,000, realizing a gain of $50,000 then such individual would be liable for a capital gain on $25,000. However, if the residential property is also a taxpayer’s principal residence, the sale is exempted from capital gain tax. This exemption is known as the principal residence exemption.
“Principal residence”, as defined in section 54 of the Income Tax Act (ITA), includes surrounding land up to ½ hectare, unless it can be shown by the taxpayer that additional surrounding land was necessary for personal use and enjoyment. To establish principal residence, three requirements must be satisfied:
- The property must be owned, jointly or otherwise, by the taxpayer;
- The property must be ordinarily inhabited in the year by the taxpayer, or spouse, former spouse, or child; and
- The property must be designated by the taxpayer to be his or her principal residence for each year.
Lets look into these requirements further:
- Ownership is Required
- For a property to be a taxpayer’s principal residence for a particular year, he or she must actually own the property in that year. This requirement is met where the taxpayer is the owner or beneficial owner of a property. Pursuant to s.54 of the ITA, joint ownership of a property also qualifies to have a property designated as a principal residence. Property must be Ordinarily Inhabited
Whether a property is ordinarily inhabited in the year by the taxpayer, or spouse, former spouse, or child is to be resolved on the basis of the facts in each particular case. The Court has interpreted ‘ordinarily inhabit’ to mean “normally occupy as a home.”
It is not necessary to show that the tax payer spends the majority of their time in that property. Although a taxpayer may inhabit a property for only a short period of time in the year (e.g., as in the case of a cottage or vacation home), this is sufficient for the property to be considered “ordinarily inhabited” in the year.
The Court will generally focus on the intention of the parties. If a principal residence is meant to be normally occupied as a home, evidence of any intention to gain or produce income on the home would be contrary to have a property designated as a principal residence.
If the main reason for owning a property is to gain or produce income, then that property will likely not be considered to be ordinarily inhabited.
- Property must be Designated as a Principal Residence
For each particular year that the designation of principal residence is sought, a taxpayer can only designate one property. For instance, if a cottage property is reported as a principal residence – no other property can be given the same designation. A T2091IND form is used to make this designation to the Canada Revenue Agency.
Beware of the Anti-Flipping Rule
It is important to note that despite the principal residence exemption, as of January 1, 2023 there is an automatic assumption under the Residential Property Flipping Rule that if you sell a residential property and own that property for less than 12 months, you will be deemed to be in the practice of ‘property flipping’ and the sale would be subject to tax. Property flipping involves purchasing residential property and reselling the same property in a short period of time (i.e., under 12 months) to realize a profit.
Despite a residential property being a principal residence, if it is purchased and sold in under 12 months, the principal residence exemption will be disallowed. However, there is an exception to this rule if a sale can be show to have occurred due to one of the following life events:
- The death of the taxpayer or a person related to the taxpayer;
- 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);
- The breakdown of a marriage or common-law partnership of the taxpayer, where the taxpayer has been living separate and apart from their spouse or common-law partner for at least 90 days prior to the disposition;
- A threat to the personal safety of the taxpayer or a related period (e.g., the threat of domestic violence);
- The taxpayer or a related person is suffering from a serious disability or illness;
- An involuntary termination of the employment of the taxpayer or the taxpayer’s spouse or common-law partner;
- An eligible relocation of the taxpayer or the taxpayer’s spouse or common-law partner (e.g., generally, a relocation that enables the taxpayer to carry on business, be employed or attend full-time post-secondary education);
- The insolvency of the taxpayer (e.g., due to an accumulation of debts);
- The destruction or expropriation of the property (e.g., where the property is destroyed due to a natural or man-made disaster).
In the case of any of the above life events, the 12-month holding period would reset once the taxpayer who entered into the sale secures ownership of the property. We have previously written about the new anti-flipping rules that became in effect as of January 1, 2023. See our previous article discussing the new rules here.
While the benefit of designating a property as a principal residence is an advantageous tax planning strategy, this article has discussed that it is not an unqualified one. For questions related to this article or legal assistance regarding a real estate matter, please reach out to one of our experienced real estate lawyers at SorbaraLAW.