15 July 2005 External T.I. 2004-0099751E5 - Principal residence exemption

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: General comments on principal residence exemption.

Position: General comments.

Reasons: General comments.

XXXXXXXXXX 						2004-009975
							Karen Power, CA
(613) 957-8953
July 15, 2005

Dear XXXXXXXXXX:

Re: Principal Residence

We are writing in reply to your letter of September 7, 2004 requesting our views on the application of the principal residence exemption under paragraph 40(2)(b) of the Income Tax Act (the "Act") to a particular fact scenario. We apologize for the delay in responding to your query.

Our Comments

The particular circumstances in your letter on which you have asked for our views involve a factual situation concerning a specific taxpayer. As explained in Information Circular 70-6R5, it is not the Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. However, we are prepared to offer the following general comments, which may be of assistance.

The Canada Revenue Agency's position on the "principal residence exemption" is set out in Interpretation Bulletin IT-120R6. 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.

For a property to be a taxpayer's principal residence for a particular year, the taxpayer must designate it as such and no other property may have been so designated by the taxpayer for the year. Furthermore, for taxation years after 1981, only one property per family unit can be designated as a "principal residence".

A taxpayer's designation of a property as a principal residence for one or more taxation years is to be made in his or her income tax return for the taxation year in which he or she has disposed of the property or granted an option to another person to acquire the property. The designation form used for this purpose is Form T2091(IND), Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust). However, in accordance with our practice, Form T2091(IND) generally need only be completed and filed with the taxpayer's income tax return where a taxable capital gain on the disposition of the property remains after using the principal residence exemption formula (see paragraph 7 of IT-120R6).

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 question of whether a housing unit is ordinarily inhabited in the year by a person must be resolved on the basis of the facts in each particular case. Even if a person inhabits a housing unit only for a short period of time in the year, this is sufficient for the housing unit to be considered "ordinarily inhabited in the year" by that person. For example, even if a person disposes of his or her residence early in the year or acquires it late in the year, the housing unit can be considered to be ordinarily inhabited in the year by that person by virtue of his or her living in it in the year before such sale or after such acquisition, as the case may be.

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.

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, 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 that will be realized from the sale of the residential property in 2005. If 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 income.

However, in the event that the gain is considered to be on account of capital, and the property qualifies as a "principal residence" an exemption may be claimed to reduce or eliminate the gain on disposition.

Copies of Interpretation Bulletins and Information Circulars 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 that our comments are of assistance to you.

Yours truly,

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch