One of the most common and biggest tax savings measures available to Canadians is the principal residence exemption from capital gains tax. Ordinarily, if you sell a property for more than you paid to buy it, you have a capital gain and you are required to pay tax on that capital gain. However, if the property is your primary residence, you can claim the principal residence exemption and avoid paying that tax. If you have a recreational property (such as a cottage, cabin, or condo) where you live part of the year, you can claim the principal residence exemption on that property. You may even be able to claim the principal residence exemption on a property outside of Canada. However, there’s a catch — you can only claim the exemption on one residence at a time. For example, let’s say you bought your house and also inherited a cottage in 1999. In 2011 you decide to move houses, but you plan to keep the cottage. Let’s say the house appreciated in value by $50,000 in that time and the cottage has appreciated in value by $225,000. For the years 1999 to 2011, you can claim the principal residence exemption on only one of the properties. Although you do not plan to sell the cottage anytime soon, it may be wiser to pay the small amount of tax on the capital gain on your house (you will have to pay tax on an extra $25,000 of income) and preserve the ability to claim the much larger exemption for those years on the cottage at a later time when you decide to sell. You should seek specific advice at the time to determine which is the better option.
If you do not want to claim the exemption on your house when you sell it because you want to save it for later, you need to file Form T2091-(IND), “Designation of a Property as a Principal Residence by an Individual.” If you fail to file this form, the CRA will assume that you are using your exemption to eliminate the gain, and, therefore, you will not be able to use it for another property for those years.
You can also minimize the amount of tax you pay by keeping good records of the capital costs that you put into both properties. Any capital expenditures that you make will reduce the amount of any future capital gain. A capital gain is commonly explained as the difference between the sale price you receive and the amount you paid to buy the property. But technically the gain is the difference between your “proceeds of disposition” (usually your sale proceeds) and your “adjusted cost base” (your purchase cost plus capital costs). In order for a cost to be a capital cost, it has to be for a lasting improvement to the property. If the expense represents something that is used up in the year or is replacing something that was used up, it will not qualify as a capital cost. For example, gas and power are used up; therefore, utility bills are not considered to be capital costs. Similarly, renovations to replace worn items (such as wall to wall carpet) are not capital expenses. However, a lasting improvement over and above the property’s original condition is a capital expense. Using the previous example, adding a new carpet to a floor that had never had carpet would be a capital cost. The property’s original condition is its condition when you purchased the property. In other words, if the roof was in terrible shape when you bought the property, the cost of a new roof would be capital, while replacing the roof 15 years after you bought the property with similar roofing material would not be capital.
Keeping track of capital expenses can make a big difference when it comes to determining whether you should claim the exemption on your house or your second property. These receipts must be kept for at least three years after you have sold the property.