Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Whether the gain on the sale of a residence will be eligible for the "principal residence exemption".
Position: Question of fact.
Reasons: Exemption available only if expected gain from sale is on capital account and conditions in the definition of "principal residence" are met.
P. Massicotte, CA, M.Fisc.
August 11, 2004
Re: Principal Residence Exemption
We are writing in reply to your letter of April 5, 2004 wherein you ask whether the principal residence exemption under paragraph 40(2)(b) of the Income Tax Act (the "Act") would be available in the situation where you acquired by way of gift a property from your mother which you extensively renovated and intend to sell within a short period of time.
Written confirmation of the tax implications applicable to particular transactions is given by this Directorate only if the transactions are proposed and are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R5 (a copy of which is enclosed). Where the particular transactions are completed, all relevant facts and documentation should be submitted to the appropriate taxation services office for their views. Although we are unable to provide any opinion in respect of the specific transactions you propose to carry out, we have set out some general comments that may be of assistance.
The Canada Revenue Agency's position on the "principal residence exemption" is set out in Interpretation Bulletin IT-120R6. We have enclosed a copy of the interpretation bulletin for your information.
If a property qualifies as a "principal residence", an exemption can be claimed under paragraph 40(2)(b) of the Act to reduce or eliminate any capital gain otherwise realized on the disposition of the property. The term "principal residence" is defined in section 54 of the Act. In order for a property to qualify for a designation as a taxpayer's "principal residence" for a taxation year, it must be demonstrated, among other things, that he or she owns the property, and that it is ordinarily inhabited in the year by the taxpayer or the spouse or common-law partner, former spouse or common-law partner or child, of the taxpayer.
A taxpayer can designate only one property as a "principal residence" for a particular taxation year. Furthermore, for taxation years after 1981, only one property per family unit can be designated as a "principal residence".
If the land on which the housing unit is situated is one-half hectare or less, it will usually qualify as part of the taxpayer's "principal residence". Land in excess of one-half hectare may also qualify but only to the extent that it is established by the taxpayer as being necessary for the use and enjoyment of the housing unit as a residence. Paragraphs 14 to 16 of IT-120R6 provide additional information on this issue.
The principal residence exemption rules recognize that a taxpayer can have two residences in the same year, i.e., where one residence is sold and another acquired in the same year. The effect of the "one plus" in the formula used to calculate the exemption (as described paragraph 8 of IT-120R6, variable B) is to treat both properties as a principal residence in such a year, even though only one of them may be designated as such for that year. In that context, even if a person inhabits a housing unit only for a short period of time in a year, this is sufficient for the housing unit to be considered "ordinarily inhabited in the year" by that person.
We wish to draw your attention however to the fact that the above comments in IT-120R6 have been made in respect of property that is capital in nature and not property that is held on account of income. It must therefore be determined whether any gain that would be realized on the disposition of your property would be on account of income or capital.
A gain arising on the sale of real estate may be considered to be business income or a capital gain. The word "business" is defined in subsection 248(1) of the Act and includes, among others, an adventure or concern in the nature of trade. This definition can cause an isolated transaction involving real estate to be considered a business transaction. Any gain or loss that arises from a business is, by virtue of section 9 of the Act, required to be included in computing income or loss, as the case may be.
As mentioned in Interpretation Bulletin IT-218R, Profit, Capital Gains and Losses from the Sale of Real Estate, Including Farmland and Inherited Land and Conversion of Real Estate from Capital Property to Inventory and Vice Versa (copy enclosed), there is no provision in the Act which describes the circumstances in which gains from the sale of real estate are to be determined as being on account of income or capital. However, in making such determinations, the courts have considered different factors. The issue generally involves a determination of the facts of each case. A taxpayer has to establish, on a balance of probabilities, that when the property was acquired, he or she did not have either a primary or secondary intention of selling it at a profit. The facts you submitted cannot allow us to draw definitive conclusions as to the nature of the gain you expect to realize from the sale of the residential property you acquired from your mother by way of gift. However, in the event the gain is considered to be on account of income, no exemption would be available under paragraph 40(2)(b) of the Act and 100% of the gain would required to be included in your income. You may wish to consult, among others, the following publications which may be useful in determining whether expenses incurred for the purpose of gaining or producing such income is deductible:
· T4002 Guide - Business and Professional Income;
· IT-521R - Motor Vehicle Expenses Claimed by Self-Employed Individuals;
· IT-99R5 (Consolidated) - Legal and Accounting Fees;
· IT-121R3 - Election to Capitalize Cost of Borrowed Money (Archived);
· IT-153R3 - Land developers - Subdivision and development costs and carrying charges on land;
· IT-364 - Commencement of Business Operations; and
· IT-487 - General Limitation on Deduction of Outlays or Expenses.
Copies of the above publications are available from your local tax services office or on the Internet at the following site - http://www.cra-arc.gc.ca/formspubs/type/menu-e.html.
We trust the above comments are of assistance to you.
Milled Azzi, CA
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch
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