Proactive and preemptive tax strategizing is important when filing an income tax return. The income and excise taxation of Canadian real estate would primarily depend on two things, the use of the property such as a place of residence, an operating business, a rental property or any combination thereof, and your Canadian residency as defined under the Income Tax Act (“ITA”)
Residents of Canada are eligible for tax rebates on the GST (soon to be harmonized into HST) and land transfer tax for a newly constructed house. For property purchased merely as your principle place of residence, the gains from a future sale of the property will not be taxed. However, if the property was initially purchased for rental purposes and eventually used a as residence, income taxes will be applied on two sources. The first being initially on the rental income earned as investment income, taxed at your normal marginal tax rate. Believe it or not, most people invest in real estate for rental income. The growth potential to earn is their main reason to engage in real estate. Thus, a portion of your home or your second residential property may be converted to generate rental income. If you incurred rental losses where expenses exceeded the gross rental income, these losses can be used to offset any other income.
The second applicable income tax consequence (and many do not know this) is on any gains (Capital Gains) calculated as the difference in value from the original purchase price (including all closing costs) and the fair market value at the point it was converted from a rental property into your residence. All capital gains income can be set-off against any capital losses, the net capital gains are then cut in half (50%) to become your taxable capital gains income at your normal marginal tax rate. Once converted into your principle place of residence, the future gain on the sale of the property from the difference in the selling price to the fair market value assessed at the point of conversion (while you are a resident of Canada) is tax-free. This is referred to under the ITA as the the Principal Resident Exemption (PRE). As a single person or under marriage (or common-law), the individual or the family unit respectively, is entitled to one designated principal place of residence within any given year. Hence, if you or your family is interested in owning a second residence such as a cottage or condo; strategizing on how and when to exactly designate which home will be your principle place of residence at which time is crucial in minimizing your tax liability.
The definition used to qualify your residential property under the Principal Residence Exemption is that a family, including you, your spouse or common-law partner, and any unmarried children under the legal age of 18, must ordinarily inhabit the property during each year of ownership. The flexibility is in designating which residential property you lived in, during any given year, as your principle place of residence. If you lived in more than one property during any given year, it would only be wise to designate the property with the highest increase in value as your principle place of residence for that year. For those of you with more than one home or property it would be wise to speak with Levy Zavet PC on how to best manage your estate and organize your affairs so that to minimize your tax burden.