Principal Residence Exemption
The Principal Residence Exemption is a tax provision in Canada that allows individuals to claim an exemption from capital gains tax on the sale of their principal residence. However, there are rules and conditions associated with the PRE, and there are situations where a deemed disposition might occur. Additionally, the 45(2) and 45(3) elections are used to manage these situations. Let's break down these concepts:
Principal Residence Exemption:
- The Principal Residence Exemption (PRE) is a tax benefit in Canada that allows individuals to avoid paying capital gains tax on the sale of their primary residence.
- To qualify for the PRE, the property must be designated as your principal residence for each year you own it. You can designate only one property as your principal residence for a given year.
- The PRE covers the years you designate your property as your principal residence, as well as one additional year (the "plus one" rule).
- The PRE applies to both houses and certain types of housing units (e.g., condominiums, apartments) as long as they meet certain criteria.
Potential Deemed Dispositions: In some cases, even if you don't sell your primary residence, a "deemed disposition" might occur, which means that for tax purposes, it is treated as if you sold the property. This can happen in the following situations:
- Change in Use: If you change the use of your property (e.g., from a primary residence to a rental property), a deemed disposition might occur. This can trigger a capital gains tax liability.
- Change in Ownership: If the ownership of the property changes (e.g., due to a divorce or inheritance), it may be deemed disposed of.
- Absence from the Property: If you are absent from your property for a period, it may be deemed disposed of for that period.
- In cases of deemed dispositions, the PRE can often be applied to mitigate the capital gains tax.
45(2) Election to Defer Capital Gain on Change in Use from Principal Residence to Income Producing Property
- A 45(2) election is used when you change the use of your property from a principal residence to an income-generating property (e.g., a rental property).
- By making a 45(2) election, you can defer the capital gains tax until you actually sell the property.
- The election restricts the taxpayer from deducting capital cost allowance on the property.
- The election is due at the same time as the taxation year in which the deemed disposition occurred.
- The principal residence exemption can be extended up to 4 years while the property is rented out if this election is made.
45(3) Election to Defer Capital Gain on Change in Use of a Property from Income-Producing to Principal Residence
- A 45(3) election is used when you change the use of property from income-generating (e.g., a rental property) to a principal residence.
- The election is available only where capital cost allowance has not been claimed on the property.
- The election is due in the taxation year that the property is eventually disposed of.
- The election allows the taxpayer to look back and claim 4 years for the property as their principal residence.
It's important to note that the rules surrounding the PRE and the elections are complex, and the tax implications can vary depending on your specific situation. If you are considering changes to your property's use or are dealing with potential deemed dispositions, it is highly advisable to consult with a tax professional or accountant who can provide guidance and help you make the most tax-efficient decisions. Additionally, keeping detailed records and accurately reporting changes in property use to the CRA is crucial to ensure compliance with tax laws. Please Contact Us for more information.