DAVID WILKENFELD, CA, canadian tax CONSULTANT

Posts Tagged ‘Principal Residence’

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What’s Your Tax Issue? Residence in a Trust

In Canadian Income Tax, Personal Tax, Principal Residence on January 7, 2012 at 8:19 pm

Our House is a very very very fine house

                  –Crosby, Stills, Nash & Young

The Tax Issue

I am a member (beneficiary) of a family trust that was set up years ago by my Dad. The trust currently owns two houses. I live in one, and my sister, who is also a member of the trust, is married and lives in the other. We were told that we will have taxes to pay we sell our homes. Can this be true? Please help, as no one seems to know the answer.

The Answer

The principal residence rules that apply to personal trusts are surprisingly restrictive and can be a trap for the unwary.

A trust is treated as a person for tax purposes. As such, it does have access to the principal residence exemption on the sale of a home. But here’s the kicker: if a trust designates a home as a principal residence for a given year, then every beneficiary of that trust who lived in a home owned by the trust is deemed to have made the designation. And remember, a person can only designate one property as her principal residence. This applies to a trust as well. This means that if you sell the home you are living in and the trust claims it as a principal residence, then when the trust sells your sister’s home, the trust is precluded from making the designation on the second home. Her home becomes ineligible for the exemption for those years even though it may be the only home she’s lived. This might come as a shock, and it seems unfair, but that is the way the law works.

So, let’s look at an example. Say the trust owned your home since 2000 and it is sold in 2012 at a gain of $500,000. Furthermore, let’s assume the trust owned your sister’s home since 1996, and sells in 2012 at a gain of $400,000. If the trust claims the full principal residence exemption on your home, then it will be precluded from claiming the exemption for the years 2000 – 2012 on your sister’s home. In fact, for the 16 years the trust owned your sister’s home, only 4 will qualify, so only 4/16 of the gain will be exempt. (Actually, the formula generously adds 1 year to numerator, so technically 5/16, or $125,000 of the total gain will be exempt).

Taxpayers thinking about placing personal homes in a family trust should always seek professional tax advise.

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What’s Your Tax Issue?

In Canadian Income Tax, Non-residents, Personal Tax, Principal Residence on March 15, 2011 at 4:10 pm

Tax season is upon us, and here at The Tax Issue, the questions are streaming in at a furious pace. I had a few free minutes this afternoon, so I thought I’d tackle some of the backlog.

The Tax Issue:

My partner and I each have holding companies that have joint ownership of our operating company.  If we wanted to sell a 1/3rd share in the operating company is there a mechanism to utilize our personal capital gains exemption?

The Answer:

The capital gains exemption is a $750,000 lifetime limit available to all Canadian resident individuals. It can be used to shelter capital gains on the sale of either qualified farm property or qualified shares of a small business corporation.

Since the shares of your operating company are held through a holding company, the exemption would not be available in the situation you describe. Your holding company would be the vendor of the shares and the exemption is available to individuals only.

Having said that, there may be some “reorganization” of shares you could perform to get you into a better position. Such planning would go beyond what I could explain here, so I would explore these options with a tax professional.

The Tax Issue:

I am a Canadian living/working in the US and considered non-resident of Canada for tax purposes. I do have a rental property in Canada and looking for an easy way to file my income tax on the rental property. What I have read so far makes me believe that I must file my taxes through an agent in Canada. I am wondering if I can file my taxes without using an agent and what is the process to do that.

The Answer:

The short answer is that you do not need to file a tax return through an agent.

Since you are a non-resident of Canada, the Canadian person who pays you rent must withhold taxes and remit them to the CRA on a regular basis. This person could be your tenant directly, or a Canadian agent who manages the property and collects rent on your behalf. Either way, there has to be a Canadian responsible for withholding and remitting these taxes.

You then have the option of filing a tax return under section 216 of the Income Tax Act. The taxes previously withheld would be treated as a credit against your taxes payable. There are two options for withholding and filing under section 216. I have discussed this mechanism in a previous post. Check it out. Also, the CRA has an extensive section on their web site dealing with the issue.

The Tax Issue:

My mother passed away in 1995 and my father gifted her 50% portion of a house to me, however kept himself on title for the other 50%.   He had another house that he resided in.   He kept his name on solely to protect my interest in case of divorce.    He passed away in May 2010 and now I’m told that I may have to pay capital gains.   I don’t understand why I have to pay capital gains if I’m not selling the property and the property has been my principal residence.   He had nothing to do with the house.   Is there anything I can do to avoid paying this capital gains tax?

The Answer:

Unfortunately, it sounds like your father was the owner of more than one principal residence. Upon the death of an individual, he is deemed to have disposed of all his capital property at fair market value. That includes any real estate he owned. There is an exemption for a principal residence. The definition of “principal residence” includes, not only the house he lived in, but can also include a house occupied by his child. The downside is that his estate can only claim one property as a principal residence.

Your father’s executor will have to determine which of the properties he should claim as his principal residence in order to minimize the taxes on his death. I would call in the help of a good tax accountant to crunch those numbers.

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What’s Your Tax Issue? More Personal Property Issues

In Canadian Income Tax, Personal Tax on February 2, 2011 at 3:30 pm

The Tax Issue:

In 2002, my parents put their principal residence in joint tenancy with my husband and myself. We lived on the property for a period of time. We have, since 2002, contributed to repairs and upkeep. In 2005, my father died. In 2010, my mother died. We currently use the home as a seasonal property but we plan to rent it out a few weeks of the year in order to have it pay for its upkeep. What I am wondering about is Capital Gains Tax. I am sure our portion (or maybe all of it minus the costs incurred and that step-up thing?)is subject to it, however, is it only payable if the property is sold? Also, is the step-up determined from when we received our interests in the property in 2002 or when it was no longer my mom’s principal residence (because she died) in 2010?

 
Hey, as an aside…do you recommend claiming rental income from a seasonal vacation rental as “rental income” on a personal tax return or as “business income” on a personal tax return (I did register my husband and myself as a general partnership – if that matters)…you probably recommend that the time has come to hire an accountant, right? ;-)

The Answer:

OK, let’s tackle the easy question first. You will only pay capital gains tax on the property when it’s sold.

Now, when your parents transferred the property to you in 2002, they had a deemed disposition at fair market value, so that your cost is equal to the value of the property at that time. If you have made any capital improvements since that time, you may add those to your cost.

When you sell the property, a portion of the gain may be exempt if you claim the property as your principal residence. That’s not such an easy decision to make. You can designate only one property as a principal residence in any given year, so if you owned any other residence, you may want to save those years for the property with the higher accrued gain.

Next, rental income must be reported as “rental income” not “business income”. There is no choice in the matter. Registering as a partnership doesn’t really change a thing, other than you’ve protected your partnership’s name, if any.

And finally, nothing beats a good accountant. They’re cute, warm and cuddly and yes, I do recommend you use one.

Good luck!!

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Mortgage Interest – It’s On The House!

In Canadian Income Tax, Principal Residence on October 13, 2010 at 3:16 pm

It’s not often that a tax planner gets a freebee, so I’m just  giddy about this one! A recent tax court case and a related CRA opinion both give a detailed description of a tax plan and both say it’s OK!

Let’s say you have a home that is mortgage-free. You’ve decided to buy a new home, and convert your old home to rental property. If you simply move out and purchase a new residence and take a mortgage to finance it, the interest on that mortgage will not be tax-deductible, since the proceeds of the loan are used to purchase a residence. Meanwhile, your rental property (your former residence) is still mortgage-free – not the best result.

So, here’s the plan: First, sell your existing home at fair market value to someone you trust – let’s say it’s your brother. Your brother pays you with a promissory note. There is no income tax on the sale, because the property was your principal residence.

Next, Buy back the old home from your brother. To finance this purchase, you take out a mortgage on this home. Now that the home is to be used as a rental property, the future interest payments will be tax-deductible.

The mortgage proceeds go to your brother as consideration for the sale of the property back to you. He then uses these funds to pay off the promissory note he issued to you when he bought the old home.

You now have the funds from the promissory note in your hands. You can use this money to buy yourself a new home.

The Tax Court of Canada, in the case of Sherle v. The Queen, actually volunteered this plan as a way to make mortgage interest deductible in the above scenario, and the CRA approved it in a recent technical interpretation.

There you go — it’s on the house!

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What’s Your Tax Issue? Related Party Sale of Home

In Canadian Income Tax, Principal Residence, Residency on August 30, 2010 at 10:34 am

The Tax Issue:

Hi David,

My girlfriend (soon to be fiance) and I are seriously considering purchasing her parents home since they will be moving in six months time.  Her father has offered to sell the house to us at a price that is $40,000 below the fair market value.  It is my understanding that as long as I purchase the house from him before we are married (therefore not related for tax purposes), then there will be no tax consequences for him or myself on the transaction.  However, I’m also of the understanding that if I purchased the house from him after we were married than there would also be no tax consequences for him or myself since he would have use of his principal residence exemption which would eliminate any tax on the deemed capital gain resulting from selling the house to me at less than FMV.  Is this correct?  Also, does the fact that my girlfriend will be contributing up to half of the down payment for the house impact the transaction in any way?
I really enjoy your website, keep up the great work! Cheers!

The Answer:

You are correct when you say that the consequences to your future father-in-law are the same no matter when you make the deal. No matter what his proceeds or “deemed” proceeds are, any gain on the sale of his house will be exempt from tax (see my previous post on the principal residence exemption).

So what was your friend alluding to? Section 69 of the Income Tax Act. Let’s say the property you were purchasing was not an exempt principal residence. Section 69 contains special provisions dealing with transactions between persons who are not dealing at arm’s length. The rules are somewhat punitive in nature because they make one-sided adjustments to the price.

If the price is less than fair market value, as in your case, then the deemed proceeds to the vendor are adjusted upwards to equal that value. However, the cost to the purchaser is not adjusted and remains whatever was paid. If the price is more than fair value, the proceeds are not adjusted downward, but the purchaser’s cost is reduced for tax purposes.

So, would these rules apply to you if the sale was made before you were married? Probably, yes. The rules apply to non-arm’s length transactions. People who are related are, by definition, not at arm’s length, so if you made the purchase after getting hitched, there would be an automatic non-arm’s length situation. However, there is also a rule that states that any two people may be deemed to be not dealing at arm’s length if the facts warrant it. In your case, the facts would seem to warrant it.

Finally, the fact that your future bride is putting in part of the money won’t make any difference, because there is only one principal residence allowed between spouses, so it really doesn’t matter who makes the claim in the end, when you finally pass the property on to your kids at a generous discount, right?

Congratulations!

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What’s Your Tax Issue? – Renting Out Your Home

In Canadian Income Tax, Personal Tax, Principal Residence on July 20, 2010 at 2:59 pm

The Tax Issue:

I live in Ontario and own a house.  I’m thinking about renting out the house (to supplement my income).  I bought the house in 1986 with my then-husband for $85,000, both of our names were on the deed.  We separated in 2006 with me remaining in the house; then divorced in 2008 at which time I ‘bought him out’ of the house resulting in the house being solely in my name.  The house is currently valued at approx. $260,000.  If I move out, rent it out, then decide to sell it within 1-5 years, how do I calculate the tax I would owe re capital gains?

The Answer:

Your question actually has three “tax events” happening so it’s a good exercise for a 2nd year tax student like me (as I was at the turn of the century :-) ).

First, you bought out your husband at the time of your divorce. I’m not sure about the circumstances, but the general rule here is that regardless of the actual price you paid, your husband’s share of the original cost became your cost for tax purposes unless, at the time, you both elected on your tax returns to apply the actual price you paid.

Second, at the time you decide to move out and rent the property, there is “change of use”, which would normally result in a deemed disposition at fair market value. Since the house is your principal residence, your gain is tax-exempt.

Third, once the change of use has occurred, any future increase in value might be taxable when you sell the house. There is a special election you can make under section 45(2) of the Income Tax Act that will allow you to avoid the change in use rules and treat the property as your principal residence for up to 4 years. In order to benefit from this concession, you cannot claim depreciation during the time you rent the property. If you sell the house within the 4-year limit after making the election, then the full amount of the gain will be exempt as a principal residence. However, if you sell after the four years, then the full amount of the increase in value from the time you moved out will be taxable as a capital gain.

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What’s Your Tax Issue? – Principal Residence Exemption Form

In Canadian Income Tax, Personal Tax, Principal Residence on April 12, 2010 at 8:02 pm

The Tax Issue:

I sold my home in 2009 and I want to claim the exemption for a principal residence. If the full amount is exempt, must I fill out and file the designation form?

The Answer:

You’d be shocked at how often I get this question during tax time – that’s twice today so far! Let’s put it to rest once and for all. Briefly, the exemption provides relief from any tax on a gain on the sale of property if it was designated as your principal residence. First, your gain is calculated. Then you must determine the number of years that you occupied the property and wish to designate it as your principal residence.

In some cases, with multiple properties, it can get complicated, but in the simplest case, where you have sold your home and it was your only residence, then you will be designating all the years you owned the property, and your gain will be fully exempt.

In such a case, even though the law technically states that you must file a designation form T2091 to calculate the exemption, the CRA has stated that you don’t have to report the disposition and you don’t need to file the form as long as the full gain is exempt, and you did not make a capital gains exemption election on the property in 1994 (that’s a whole other blog – don’t ask :-) ). If you want to be super cautious, though, I would still file the form, because the CRA has been known to renege on their administrative concessions from time to time.

If you live in Quebec, although you don’t have to report a fully exempt sale of a principal residence on your tax return, you must still complete and file form TP-274 with your income tax return.  No administrative concession is given here.