Planning Issues for Taxpayers Owning Two or More “Principal Residences”
Owning more than one residence can be a taxing ordeal. Generally, Canadians are exempt from tax on the capital gains arising on the sale of a “principal residence”. Appropriate tax planning can help to manage the tax burden which arises when multiple residences are owned.
A “principal residence” is defined as a housing unit along with surrounding land of up to a maximum of one half hectare (about one acre). In cases where land in excess of one acre is deemed necessary for the use and enjoyment of the residence, it may be considered as part of the principal residence. It should be noted that the property does not have to be situated in Canada to qualify for the principal residence exemption.
For a property to qualify, it must have been ordinarily inhabited “in” the year, not throughout the year. This means, for example, that if a taxpayer sells one house and buys another in the same year, they may be considered to have ordinarily inhabited both of them. Inhabitation on a periodic basis would appear to qualify, even where the total time spent in the property is only a small portion of the year, such as with a family cottage.
Two key considerations in managing the principal residence exemption are:
- ensuring that you evaluate whether it is best to use the exemption when a particular residence is sold; and
- that you consider whether shifting future growth in the value of the property to other family members is warranted.
One advantage of transferring the cottage to the next generation now is that your tax liability would be limited, based on the current amount of gain on the property. If you expect the property to appreciate in value over time, a transfer now may be worth considering. This transfer will also have its disadvantages. Having to pay the capital gains tax now and possibly land transfer tax would require a current cash outflow. Issues related to family law and creditor protection also must be considered. You might choose to use your principal residence exemption now to shelter the tax liability and pay tax in the future on the sale of the family home.
If there is reluctance in transferring the direct ownership of the cottage to other family members due to the loss of legal control over the property, you may wish to consider using a family trust to hold the vacation property. This “deemed” disposition on the transfer of the cottage to the trust would still be a taxable event, but you would be able to continue to exercise control over the use of the cottage.
Owning two or more properties can leave your estate with a large tax burden. If there is insufficient cash available, one of the properties may have to be sold to pay the tax bill. One option here could be considering the purchase of life insurance to cover the tax liability which arises on death. This way, the family cottage can remain with the family.
There are numerous tax issues surrounding the ownership of two or more residences. Before buying or selling a secondary residence, it may be prudent to contact your local DJB office to discuss the implications with a tax professional to ensure that the purchase is structured in the most tax effective manner and the sale is less taxing, if possible.