Read “Capital Gains Tax for Dummies”
Financial planner and tax specialist Josée Jeffrey, from the Focus retirement & taxation firm, explained the fundamental concepts in a fictitious exchange evoking the sale of a chalet worth $450,000 in 2024 and paid for $100,000 12 years earlier .
She resumes the dialogue, this time with our readers.
In your example, we can add $31,310 to the purchase price of $100,000 to take into account inflation between 2012 and 2024, or 31.31%.
B. Laporte
Josée Jeffrey: No, you cannot discount your expenses or your purchase cost, i.e. index them according to inflation. Real numbers must be taken into account. I add an important detail: we must not confuse the market value and the municipal value of real estate. You will use the services of a certified or real estate appraiser to establish the fair market value.
It seems to me that before putting a second home up for sale, it can be designated as a primary residence, in order to avoid declaring a capital gain. Could you give the explanation?
L. Côté
Josée Jeffrey: Yes, you are absolutely right.
Remember that the concept of principal residence applies to several real estate properties owned by a taxpayer. A property can be designated a personal residence for a given year, provided that its use is personal and that it has been “normally inhabited” for even a single day at some point during the year. It is therefore possible that your cottage or second home may be designated as your primary residence. However, you can only designate one principal residence per year. When disposing of one or other of your main residences, you will have to choose the designation years for each, according to the added value realized. The designation is done year by year.
A residence normally inhabited by a minor or adult child, a spouse or ex-spouse is eligible as a principal residence, even if you received rental income from these people.
In addition, in the tax sense, there is a very important rule which allows one year to be added to the years designated as principal residence on each property, what is called the “+1 rule”. But let’s not go into too much detail…
Advice for owners. NOTo 1: keep your improvement invoices and do not pay under the table. NOTo 2: look at the evolution of the market value of your chalet over the last 12 years before thinking about selling before June 25. This may be your best investment for the future.
G. De Bellefeuille
Josée Jeffrey: I agree with this. A hasty sale could result in a loss of several thousand dollars in potential capital gains on the chalet.
Your advice is sound. To minimize the capital gain on a sale, it is essential to correctly establish the adjusted cost base of the cottage and principal residence where you live regularly. Indeed, to determine which of the two will benefit from the principal residence exemption, you will have to account for the expenses of all your properties for personal use.
For each, include the initial purchase price, as well as expenses for major renovations, such as adding a garage or shed, installing a swimming pool or a bathroom. Don’t forget to add acquisition costs such as transfer taxes, legal and inspection fees, keeping all supporting invoices.
I currently have a condo that serves as my chalet. If I sell it, can I include my condo fees, municipal and school taxes to increase my purchase price?
N. Mongeau
Josée Jeffrey: Oh no! Only the transfer taxes paid at the time of your acquisition will be added to your purchase price. Usually, condo fees, also called common charges, constitute maintenance and management costs. Property taxes also constitute user costs. However, if you have paid significant amounts as a special contribution, these could be added to your basic price, depending on the nature of the expense.
When selling a rental property, are the costs of improvements also added to the purchase price? I would like to know the difference between the effective tax rate and the marginal rate, and when one is used or the other.
A reader
Josée Jeffrey: Yes, the costs of major improvements are added to the purchase price.
Briefly, the effective tax rate is calculated by dividing taxes paid by total income. It gives you a quick glance at the percentage of your tax liability during the year. The marginal tax rate is the percentage of tax paid on the last dollar earned in the year. It will be useful for you to know the tax impact of certain strategies, such as a contribution to your RRSP.
I believe it is possible to defer taxation on the capital gain by not cashing out the amount immediately. It’s a reserve. Let’s assume a triplex sold for $1,000,000 with a capital gain of $600,000. We take a second mortgage (sale balance) of $500,000, or a 50% reserve. The capital gain in the year of sale is $300,000, and when the sale balance is cashed, $300,000.
A. Renaud
Josée Jeffrey: In fact, it is possible to distribute a balance of sales price to be received over the four years following the sale of the property, in this case your triplex. You will then request a provision to defer your capital gain. You must be a resident of Canada on December 31 of the tax year in question. But there really must be a balance to pay to benefit from this deferral.
You can designate a secondary residence abroad as your main residence on tax purposes in Canada.
C. Stubborn
Josée Jeffrey: I confirm that personal-use property held abroad is eligible for the principal residence exemption. There may be tax to pay in this country.
What happens to the capital gain if I inherited a cottage my father built in 1976? The chalet is now worth around 1.5 million.
A reader
Josée Jeffrey: You are deemed to have acquired this chalet at its fair market value on the date of your father’s death. For example, if his cottage was worth $800,000 when he died and you now sell it for $1.5 million, you will have a capital gain of $700,000. The calculation of the taxable capital gain will depend on all the elements mentioned above. Remember that with the new tax rules which will come into force on June 25, the tax inclusion rate on capital gains made by individuals will increase from 50% to 66.67%, but only on the portion exceeding $250,000. On the first $250,000, the inclusion rate remains at 50%, which means that 50% of this gain is added to the taxable income of the year.
Attention ! There are three key dates to consider when calculating the capital gain for your father’s cottage. Before 1972, the concept of capital gains did not exist. If your father owned the cottage on that date, it is essential to determine its value on December 31, 1971 to exclude it from the calculation. In addition, before 1982, each spouse could have their own principal residence, each thus benefiting from the capital gains exemption.
On February 22, 1994, taxpayers were able to use their old $100,000 lifetime exemption on their capital assets. It is possible that your father used this exemption by designating his cottage, which would increase its current cost.
I can’t get a clear idea regarding the new capital gains standards. In 2006, my partner and I bought an old cottage on the waterfront for $130,000. In 2014, we completely demolished the chalet to build a house which has since become our main residence. The valuation at that time rose to $350,000. In 2024, according to the new assessment roll, our property is now worth $600,000. We have no other property.
S. D’Amours
Josée Jeffrey: We will assume that you occupied another main residence before the construction of the new country residence in 2014.
For your property, your base price will include your purchase cost of $130,000 in 2006, plus all your other construction costs, including demolition costs.
I remind you that when calculating the capital gain of a residence, you must take into account the market value and not the property assessment.
Here’s a quick calculation assuming a market value of $650,000 on the one hand, and a rebuilding cost of $320,000 (including demolition costs) plus your 2006 cost of $130,000 on the other.
If you sell it in 2024:
- Capital gain before the principal residence exemption ($650,000 – $130,000 – $320,000): $200,000
- Years owned: 19 (2006 to 2024)
- Years designated as principal residence: 11 + 1 (years 2014 to 2024, plus one year under the “+1 rule”)
- Capital gains exemption (12 years out of 19, or 63.2%): $126,316 ($200,000 * 12 / 19)
- Capital gain to declare: $73,684 (subject to the 50% inclusion rate) = $36,842 divided between the two co-owners ($18,421 each)
The longer you keep your residence, the more the exemption percentage will increase. Of course, the market value will also increase! But you won’t complain…