Whether it’s a simple paint job or a major renovation, chances are your home has undergone a few modifications since you originally purchased it. While replacing that old 80’s carpet with hardwood floors likely won’t impact your tax return, a changing how you use your home likely will. Converting all or part of your principal residence to earn income from business or rent can have tax consequences and affect how you complete your return.
What is a Principal Residence?
As the name implies, your Principal Residence (PR) is the main home where you and your family reside. Your PR could be a house, condo, mobile home, cottage, houseboat, etc. In the simplest terms, it’s the place where you live the majority of the time. If you sell your PR after 2017, you are required to report the sale on Schedule 3 of your tax return, as well as fill out Form T2091(IND).
The Principal Residence Exemption
In Canada, if you sell property for more than you paid for it, your profit is usually subject to capital gains tax. Your PR, however, is usually exempt from capital gains rules. If you’ve made a tidy profit from the sale of your PR, all you’ll need to do is report the sale details on your tax return. As long as your home was your principal residence for the entire time you owned it, your profit will not be taxed.
For example, imagine you purchased your home 10 years ago for $100,000. Last month, you sold it for $300,000.
If the property was wholly used as your PR for the entire 10 years (not used as a business or rental), the $200,000 profit you made is completely exempt from tax. You just need to report the details of the sale on your tax return.
But if your principal residence was used to earn income, different rules apply. When you sell, your profit may not be exempt from tax.
Change in Use
If you operate a business from your home or rent out part (or all) of your residence, you’re changing the use of your property from residential to income-earning. Because the PR exemption applies only to the time your home was just your residence (and earned no income), you may be subject to capital gains rules when you sell. The good news is that the PR exemption will still apply to the years that your home was purely a residence.
Let’s revisit the example above. You purchased your home 10 years ago for $100,000 and sold it last month for $300,000. However, imagine you decided to move in with your daughter to help raise her twins two years ago. You opted to rent out your property rather than selling right away. At the time you began to rent it out, your home had a fair market value of $250,000.
Because of the change in use from residential to rental, your tax situation also changes when you sell the property. Here’s how:
- For the first 8 years, your property went up in value from $100,000 to $250,000. Since it was still only your principal residence (didn’t earn any income), that $150,000 profit isn’t subject to capital gains tax.
- During the two years your property was a rental, the value went up by $50,000 ($250,000 to $300,000). Because the property wasn’t your primary residence during that time, the $50,000 is subject to capital gains tax.
- You’ll report the sale of the property on your tax return and complete form T2091 to calculate the exact amount of capital gains tax owing.
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