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Capital Gains - Real Estate
April 22, 2021
11:18 am
jt23
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Hello,
What if a person bought a 2nd home (cottage) in 1972 for personal use and then sold their principle home in 1993 and moved to the cottage fulltime as the principle home until it was sold in 2020. Would Capital Gains on the 2nd home (cottage) only apply from 1972-1993 and remaining years 1993-2020 would be tax except as it was principle home? If so, how is that calculated in the tax return? Is it a "deemed disposition" in 1993 and a Fair Market Value estimate is used to calculate Capital Gain or is it a "change of use" declaration in 1993 and same FMV estimated is used for capital gains calculation? Does any one know the logistics on how to file this in the tax return?
Thank you

April 22, 2021
2:15 pm
Norman1
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All the details are described in Chapter 6 (Principal Residence) of the T4037 Capital Gains 2020 Guide.

April 22, 2021
2:44 pm
jt23
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Hi Norman, thank you for your response. I just found a couple articles that imply "change of use" would apply. This means the owner would be tax exempt for all gains between years 1993-2020 based on a Fair Market Value evaluation in 1993 (the time the 2nd home became the principle residence). These are the articles... https://www.moneysense.ca/columns/capital-gains-tax-declaring-a-new-principal-residence/ and https://eriesedge.com/2018/02/capital-gains-cottage

Does this make sense? It does to me, but am struggling how to capture this calculation within the tax return.

April 22, 2021
4:08 pm
Norman1
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Did you actually have changes in use between personal-use and income-producing use?

That's not necessarily the same as changes in principal residence between different personal-use properties.

You bought your cottage in 1972 for personal use. You moved into the cottage in 1993 and the cottage became your principal residence. Cottage continued to be personal use. Cottage was still your principal residence and personal use when sold in 2020.

Looks like cottage was personal use 1972 to 2020. Cottage was principal residence 1993 to 2020.

April 22, 2021
5:56 pm
Norman1
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When there's no change in use between income-producing use and other-than-income-producing use, the T2091 calculations effectively prorate the principal residence exemption.

The prorating is done using the number of years the property was the principal residence and the number of years the property was owned.

Examples are in A Guide to the Principal Residence Exemption from BMO Wealth.

April 22, 2021
6:21 pm
Bill
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Check out form T2091, it'll show you the calculation.

I believe nothing happens, assuming it was never a rental property, until you sell a property and then you can choose what years (during the time you owned it) you want to designate it as your principal residence. If you have 2 properties that you've used as residences, e.g. cottage and a city property, you can designate either one as your principal residence for any year for capital gain purposes, doesn't actually have to have been your principal residence for that year.

So when you sold your principal residence in 1992 you could decide how many of the years you lived in it you want to apply the principal residence exemption to the capital gain. Then same process for when the cottage was sold in 2020. Just can't use the same year for both properties.

In my case, I'll sell my cottage before my principal residence but I'll designate it as my principal residence for 100% of the years I owned it so I don't have to pay any capital gains tax on it. So if the taxable capital gain is $400K (say) I'll shelter 100% of it. When I die later and my house is sold they'll be unable to use the principal residence exemption for the years I already used it for the cottage, so if the gain is $800K and I lived in it for 50 years but used 40 years for the cottage exemption then my estate will only be able to shelter $800K X 10/50. Is the tentative plan, maybe someone can tell me if I'm making any mistakes here.

April 22, 2021
6:28 pm
Bill
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Note also, per T4037, "For years before 1982, more than one housing unit per family can be designated as a principal residence. Therefore, a husband and wife can designate different principal residences for these years." Cool for cottage owning couples for the years prior to 1982.

April 22, 2021
8:38 pm
Norman1
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Depending on the circumstances, OP's cottage could be a principal residence also from 1972 to 1981!

April 23, 2021
5:50 am
jt23
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All, thank you for the responses. Some additional background for everyone to understand why I'm pushing for a FMV calculation in 1993 due to change of use...
In 1993 the FMV value of the cottage was actually less than the investment cost (i.e. purchase + upgrades). That was due to the real estate market crash between 1989-1993. So essentially the cottage had a Capital Loss between 1972-1993 and all Capital Gains of the cottage were actually realized between 1993-2020. If the calculation forces me to prorate the capital gains across all years of ownership and then apply to only years it was a second home 1972-1993, I would inherently pay for Capital Gains between 1972-1993 for gains that were not realized during that period. Does that make sense? I'm struggling to pay Capital Gains for those years when the gains were not realized in those years. The "change of use" calculation which takes into consideration FMV in 1993 would address that issue. However, the "change of use" in 1993 was only from "2nd home" to "Principle Residence", so not sure if that applies to CRA's definition of "change of use". If it does I think I'd would be good to go.

Thoughts?

April 23, 2021
6:39 am
Norman1
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According to Income Tax Act 45(1), there is only a deemed disposition for changes in use between

  1. "for the purpose of gaining or producing income" and
  2. "for some other purpose".

Changing one's principal residence designation from one personal-use property to another personal-use property, by itself, does not count for that. Both properties remain in the same "for some other purpose" use.

I don't see what the issue is. If I buy a stock at $100 and it dips to $50 before powering up to $200, then, when I sell at $200, I'm going to owe taxes on

$200 - $100 = $100 of gains.

There's no compensation for holding the stock as it dropped all the way down to $50 before it went to $200.

April 23, 2021
8:03 am
jt23
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Hi Norman, yes I understand what you are saying and do not disagree. What is confusing to me is that both of these articles https://www.moneysense.ca/columns/capital-gains-tax-declaring-a-new-principal-residence/ and https://eriesedge.com/2018/02/capital-gains-cottage
state that "According to the CRA a deemed disposition is a change of use in a property. In your case, you changed the use of your vacation property (to your primary residence) after you sold your home and moved in to the vacation property. From a tax perspective, you owe tax on any price appreciation in the first 14 years you owned the property. However, for the remaining 14 years—when you lived in the property as your principal residence—any appreciation in value is exempt from capital gains tax."

April 23, 2021
8:40 am
Norman1
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The articles presume that the owners were renting out their cottage before they turned the cottage into their full-time principal residence. That's not always the case. I don't think that was the case in your situation.

When articles don't agree with the Income Tax Act, guidance from CRA, or the tax forms, I go with the latter.

Sometimes articles are bad and are written by people who don't quite understand the details. One such article was recently discussed in Renting out basement apartment below fair market value.

That article erroneously said that one can make rental income tax free by just charging below market rent. Charge $1,600/month for the basement when everyone else is charging $1,800/month and the $1,600/month or $19,200/year is tax free. If only that were true!

April 23, 2021
8:58 am
Bill
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I agree, Norman1, the examples in the articles are at odds with CRA form T2091 method, which does not isolate specific periods but does it on a straight-line basis, i.e. a $500K gain over 20 years is presumed to have occurred evenly over those years. That's the CRA requirement for cases where there has been no other use than personal (sometimes principal residence, sometimes secondary residence) use.

Having said that, maybe someone could challenge the T2091's and the Guide's directions, argue that that arithmetically convenient and easy method is at odds with the actual intent of the legislation which is to exempt from capital gains increases in value only during the actual time the property was used as a principal residence. Maybe someone's already done that, maybe there's already jurisprudence on that.

April 23, 2021
10:22 am
Norman1
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There is no such intent in the legislation.

Income Tax Act 40(2)(b) prescribes that formula. B is actually one plus the number of years that the property was principal residence. Government did not intend to be exact:

40(2)(b) where the taxpayer is an individual, the taxpayer’s gain for a taxation year from the disposition of a property that was the taxpayer’s principal residence at any time after the date (in this section referred to as the “acquisition date”) that is the later of December 31, 1971 and the day on which the taxpayer last acquired or reacquired it, as the case may be, is the amount determined by the formula

A - (A × B/C) - D

where

A is the amount that would, if this Act were read without reference to this paragraph and subsections 110.6(19) and 110.6(21), be the taxpayer’s gain therefrom for the year,

B is

(i) if the taxpayer was resident in Canada during the year that includes the acquisition date, one plus the number of taxation years that end after the acquisition date for which the property is the taxpayer’s principal residence and during which the taxpayer was resident in Canada, or

(ii) if it is not the case that the taxpayer was resident in Canada during the year that includes the acquisition date, the number of taxation years that end after the acquisition date for which the property was the taxpayer’s principal residence and during which the taxpayer was resident in Canada,

C is the number of taxation years that end after the acquisition date during which the taxpayer owned the property whether jointly with another person or otherwise, and

D is …

April 23, 2021
10:56 am
jt23
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Thanks guys. I was hoping that the CRA stance with respect to ‘change of use’ was more flexible than only 'income earning' vs 'personal use'. My approach in arriving at a realistic FMV in 1993 seems logical and more accurate than straight-line gains. Using CRA's straight-line approach enables them to cash in on capital gains between 1972-1993 when there actually wasn't any. It's disappointing that I'll be taxed on capital gains that were not realized during the period in question.

April 23, 2021
1:39 pm
Norman1
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It's not that unfair. If someone uses their cottage as their principal residence for 20 of the 30 years owned, then (20 + 1)/30 of the realized capital gains are tax free.

Someone else would be absolutely ecstatic if their price appreciation all occurred during the early years it wasn't their principal residence and the price was flat after it became their principal residence!

April 23, 2021
5:39 pm
Bill
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The "one plus" in the numerator (B) serves to include the partial year of residence in the year you sell/move, I believe.

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