On October 3, 2016 changes were announced to the computation of the available principal residence exemption. Changes were made to properties held by individuals and to properties held by trusts. Discussion below is limited to the changes affecting individuals. Changes to trust is more complex and may be addressed in another BLOG.
Simply put, the PRE is a formula that exempts all or a portion of the otherwise computed gain on the disposition. The numerator is representative of the number of taxation years in which one may designate the property as their principal residence, “PLUS 1”. The “PLUS 1” is there to allow for designation where you buy and sell in the same taxation year. Either the taxpayer, the taxpayer’s spouse or child may inhabit the property for the PR designation to be allowed. You cannot designate the property for a taxation year in which you were not a resident of Canada for tax purposes. The denominator is the number of years you owned the property.
For a non-resident who purchases a property situated in Canada for his child to inhabit, the PRE is available to the non-resident but only for 1 divided by the number of year he owned the property because the non-resident is not a resident of Canada. This means that if the property was owned for 4 years, then ¼ of the gain would be exempt. The longer the period of ownership, the lower is the exempt portion.
Effective for taxation years after October 3, 2016, the “PLUS 1” is only available to taxpayers who were resident in Canada during the year they purchased the property and non-resident purchasers of property acquired before October 3, 2016 are not grandfathered.
What happens if the taxpayer moves to the United States?
If the property is sold after departure to the U.S., the Canada/U.S. tax treaty in Article XIII, paragraph 6 provides for a bump-up to fair market value for U.S. tax purposes as the capital gain is subject to U.S. taxation. IRS Form 8833 treaty based disclosure should be filed with your U.S. 1040 return to support this position.
If a taxpayer moves to the United States but has not sold the property before ceasing residency in Canada, the “PLUS 1”, is available when filing the application for clearance (CRA form T2062/T2062A), but note the taxpayer cannot designate the PR for taxation years on completion of CRA Form T2091 (IND) in which he is residing in the United States.
What is often missed on departure to the United States?
If the property is converted to a rental either before or after departure, this is a “change in use” and requires reporting of the deemed disposition on a tax return and possibly the filing of the application for clearance. If the change in use occurs prior to departure, the reporting is on the T1 return filed for the year of departure. If the “change is use” is after departure, the reporting is on a T1 return filed under Section 115 of the Income Tax Act and the filing of the T2062. As a non-resident of Canada, by not filing the T2062 clearance application within 10 days after the deemed disposition, a late filing penalty up to $2,500 will apply. The change in use steps up the basis for Canada equal to that fair market value used as a basis for a future sale.
If a “no change in use election is filed, there is no disposition reportable, no T2062 required to be filed and no capital gain nor increase in basis. Future capital gains are from the original purchase price plus any capital additions to the property. However capital cost allowance cannot be claimed on the net rental income if a section 216 election to file a special rental T1 return to report net rental income with taxation at graduated rates as opposed to the flat 25% Section 212 non-residence tax on the gross rental.