Capital gains tax is usually a scary enough term by itself! The mere notion that half of your profit is taxed seems discouraging (it shouldn’t be). But one highly misunderstood advantage that Canadian residents have when it comes to their principal residence is what CRA refers to as the “election of subsection 45(2)” protects you from capital gain after you sell your property even if you have rented it for a few years. Lets’ dig into this more:
According to the CRA, when someone converts his principal residential property into a rental one, it is considered that the said property is “disposed of” at fair market value and immediately “reaquired” for the same amount. Any gain at the disposition of this property (time of sale), is exempted from capital gains tax under PRE (principal residence exemption), however, any profit after this is subject to capital gains tax. Example:
Joe buys a house in 2000 for $300,000. In 2005 he decides to rent out his house (for any reason). The FMV (fair market value) of his house in 2005 is $400,000 which doesn’t really matter for tax purposes as per PRE. But he decides to sell this house in 2009 for $550,000. CRA determines the capital gain to be $150,000 (remember, he has “reaquired” this house in 2005 for $400,000) and this $150,000 will be subject to capital gains tax.
Now, under certain circumstances CRA allows the taxpayer to defer any gains by electing under subsection 45(2) that a change has not been made to the use of the property. But that comes with a few conditions:
- This election is valid for up to 4 years (there are some conditions that let it run indefinitely though).
- You MUST file your rental income on this property even if the income is zero or negative.
- You must choose to exercise this right the same tax year that this change was made (you might still be able to get away with it later but more or less it would be at CRA’s sole discretion).
- No CCA (Capital Cost Allowance) must have been claimed from the time that this change happened.
- You must be a resident in Canada during those years.
- Only 1 property by you and your spouse can be allocated at any given time for this exemption.
If Joe chooses to elect the subsection 45(2) for the right reasons, he will be exempted from all of the gains by PRE in 2009. How’s that for some extra savings?
It is greatly encouraged that anyone who is interested in the subject to read the material on the CRA’s website (Tax Folio – Principal Residence) or reach out to their tax advisors for more information. Like we always say, spending money on good advisors would save you much more than not using them!