The Homeowners Principle Residents Deduction
In the past 50 years or so one thing has always been guaranteed by the government and that is the Principle Residents Deduction. If you bought a home to live in with your family, when you sold that home any profit made from the sale of that home was tax free. Claiming this deduction was simple, really you didn’t have to do anything, it wasn’t even reported on your tax return.
Well in 2016 this changed. In a move that many people may find unexpected the government has made it so that in order to claim the Principle Residents Deduction one must now report the sale of your home on your tax return. If you report the sale then the Principle Residents Deduction can be claimed and there will be no Capital Gains charged on any profit.
When I first heard of this I could see the government’s intentions. To me it sounded like a fact finding mission to determine how many people might be abusing the Principle Residents Deduction. With the real estate markets as out of control as they have been, it is natural that the number of people flipping homes has increased immensely. With that increase there has been an increase in the number of people trying to take advantage of the best tax break there is, the Principle Residents Deduction. In the last year the number of people who have come to my office and asked “How Long do I have to live in a house for it to be tax free?” has tripled or more. I hear the question almost every week.
The problem is right now there is no hard fast rule. Some people say a year, some people say six months, but the truth is it all comes down to intent. If you buy a place with the intent to fix it up and sell it, then you are technically subject to Capital Gains. If you buy several places in a row to fix up and sell, it is then a business and you can be subject to full tax on any profit. The government has had no way to monitor these sales, hence the new requirement to declare the sale on your return. This would allow them to determine how many people are selling multiple homes in a row and not having to pay tax on any of them.
Unfortunately this makes sense to me because one can argue that with the present market someone could move every year, easily make $100k in tax free income, and just say I lived in the house for a year so you can’t touch me. Essentially they could make a pretty good living and never pay a penny of tax. The government wants to know how much they are losing to this. The rule was not meant to target home owners who are buying and selling their house every four or five years just because they want to move, it was to target those who are abusing the rule in order to make a tax free profit.
This fact finding mission, I believe, is going to lead to a change in the Tax Laws. A more clearly defined Principle Residents Deduction will, most likely, be going on the books. It may limit the number of times you can claim the deduction, such as once every 2 to 4 years, or it may require you to provide more information if you are found to be selling your home too often.
My biggest problem came when I looked at the way this fact finding mission was going to be enforced. Basically Canada Revenue has said that if you fail to report the sale of your home on you next year’s tax return they can completely disallow the Principle Residents Deduction. Naturally this would be a disaster to most people, for some costing tens of thousands of dollars in tax. They have always allowed for some leniency for people who might have been unaware of the change, but in this case the only leniency they are providing is a clause that says if you forget to claim the home sale, or if you don’t file that year at all, you can change or late file your return, voluntarily claim the deduction, but then be subject to an up to $8000 penalty depending on the amount of profit made on the home. Effectively by putting these penalties in place, they are punishing everyone who sells a home and fails to report it, even those who legitimately had no intent to avoid taxes, they were just unaware.
Another disturbing fact revealed in my research is how the government has also gone out of its way to mention that people renting out part of their home, or maintaining a home office for their business, may find the portion of the house being written off subject to Capital Gains. In the past as long as the portion being written off was reasonable and less than 50% it wouldn’t effect the Principle Residents Deduction. The end results from this may be that people renting rooms in their house may stop renting them all together, helping to even further decrease the housing available to lower income people. Small businesses that can only afford to be operated out of the house on start-up may choose to shut down rather than risk the cost that could come from the sale of the owner’s home.
To sum it all up, where I understand what the government is trying to do, I can also see a danger of them putting the whole Principle Residents Deduction in jeopardy. As it is, buying and selling your home will become more complicated. You will have to keep records showing exactly what you paid, as well as keep records of any major renovations, just in case when time comes to sell there is any possibility you may have to pay tax. One can argue that the real estate market is partially to blame, along with those that are trying to take advantage, but when it comes down to it everyone has to be prepared because these rules will apply to all, not just those who are trying to profit from today’s housing market.