Point of View - Home Or Cottage Or Both – The Principal Residence Dilemma

My family was recently visiting a friend’s cottage when I was asked a question that is not uncommon: “We’re thinking of selling our cottage. We should expect to pay a lot of tax, right?” The answer: “Maybe; Maybe not.” Misconceptions around the principal residence exemption can and often do lead to unwanted and unexpected consequences.

The following are a few key things to keep in mind when you are contemplating selling a property.

What is a principal residence: A principal residence is any property that you, your spouse, or your children inhabited at some point during the year. This means that your house, your cottage, or even your trailer could be your principal residence, including property that is owned outside of Canada.

What is the impact of owning multiple properties: The main thing to remember is that only one principal residence can be designated each year for an individual and their spouse. The actual tax ramifications of this can be quite complicated.

Here is a simple example to illustrate: Dan and Sara purchased their house in 2000 and their cottage in 2005. In 2016 they decide that it is time to downsize to a smaller house. When the house is sold, Dan and Sara have a choice to make: do we designate our house as our principal residence and pay no tax today, or do we designate our cottage as our principal residence and elect to pay tax on our house sale? The usual answer to this question is to determine which property has the highest gain per year, and to choose that property.

What if I convert my cottage to a rental property: This is commonly referred to as a change in use, resulting in a deemed disposition with a possible resulting capital gain. In this situation you could use your principal residence exemption to shelter the capital gain resulting from the change in use. Alternatively, there is a rule in the income tax act, subsection 45(2), which allows you to defer the gain until the property is eventually sold, up to an additional four years.

On a large property, how much land can be my principal residence: The CRA generally allows for your house or cottage plus half a hectare. The overall gain would need to be allocated between the exempt component and the remaining land.

Calculating the principal residence exemption can be quite complicated, especially if a property has been owned for a number of years through different tax rule changes not illustrated here. Consulting a tax professional is crucial when multiple properties are owned and will help ensure that no unintended tax consequences result.