A series of new tax rules implemented across Canada in the last quarter of 2017 will have implications on homeowners and their approach to capital gains strategies. Families with more than one property should take the time to read and understand the new requirements, as a means of minimize the amount of tax owed to the CRA as well as avoiding audits and penalties. Here are 8 tips to maximize capital gains tax strategies under the new legislation.
Tip #1: It’s still possible to minimize taxes through capital gains strategies
Capital gains strategies involve strategically declaring when each property was used as a primary residence, as a means of minimizing the income tax on the property. For this strategy to work, the properties cannot have generated passive income during the years in which they were declared to be a primary residence.
Under the new rules, owners of cottages will need to report the sale of each property, which will be considered as income. To optimize the capital gains exemption, families may still designate the property with the highest accrued gain as their principal residences.
Therefore, if your cottage or holiday home accrues more equity over time than your condo or single family home, it may be declared as a primary residence to avoid the higher taxation. It is advised for homeowners with multiple properties to consult with a financial planner or a real estate agent to devise the most beneficial capital gains strategy for their particular portfolio.
Tip #2: More thorough book-keeping required
The new requirements put more onus on property owners to declare all sales, and keep all receipts and invoices related to their property. Diligently keeping records of all your costs as a homeowner will help increase your adjusted cost base (ACB) on the property, thereby reducing the owed income tax after its sale.
The new rules also require homeowners to establish fair market value through an accredited appraisal report, which will be kept on file until the transfer of ownership to another person.
Tip #3: Each sale must be reported
Starting early October 2016, homeowners will be required to report every single property sale on their tax return, whether they owe tax or not. Failing to report will put homeowners at risk of an audit or interest changes, as well as compromising their ability to apply for future principal residence exemptions.
Tip #4: Rentals are considered sales
The CRA will deem your home sold even if you decide to put it on the market as a rental property. They will consider this a “deemed disposition,” and will be taxed as a sale at current fair market value.
There are several ways to trigger a deemed disposition: renting your home, gifting the property to a third party, or leaving Canada (and therefore no longer paying taxes in Canada). The owed tax can be deferred until the property is actually sold.
Tip #5: House-flippers are not entitled to the exemption.
“House flipping” refers to the practice of buying a home under market value (usually repossessed units, or home that have fallen into disrepair), investing into renovations, and then quickly selling it at a profit.
For a property to qualify as “capital property” of the taxpayer and therefore benefit from a capital gains exemption, it cannot be part of their trade or business. Due to the short period between their purchase and their sale,flipped houses are considered “inventory” rather than “capital property.” Thus any profits generated from the sale of a flipped house can no longer be considered a capital gain, and must be considered a business income.
Tip #6: Limitations on properties owned through trusts
The new changes place limitations on the types of trusts that are eligible for capital gains exemption.
Families that own properties under trusts should review the amendments to verify whether their residences can still be designated as principal residences under the new rules. If a trust is deemed no longer eligible, the homeowner may separate gains into two components: the gain accrued until 31 December 1016, which may be sheltered by capital gains exclusion, and the gain accrued after January 2017 which will be subject to tax.
Tip #7: Foreign buyer? Read the fine print carefully.
Non-residents of Canada who own properties will no longer be able to add one year to the number of years during which the property is considered a primary residence. Under normal circumstances, Canadians are allowed to claim PRE for each year the property is owned as a principal residence, plus 1 year. This option is no longer open for non residents.
Tip #8: Expect additional measures
The introduced tax changes are aimed at investors and homeowners in Canadian real estate, and have been put in place to ensure they abide by the existing tax rules. It’s not the first time principal residence exemption has been significantly changed; one of the more significant changes occurred in the early 1980s, when each spouse was no longer allowed to claim a principal residence exemption for different properties. When it comes to the country’s real estate markets, we should expect additional changes in the near future. The Liberal government is currently assessing whether the changes will be sufficient to mobilize the desired market shifts, such as cooling off over-heated markets in Vancouver and Toronto.
All homeowners should read the new regulations from the Canadian Revenue Agency, which are stipulated in detail in the T4037 Guide: Capital Gains 2018.