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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
1. What portion of a 4.88 acre property qualifies as a principal residence for purposes of the principal residence capital gains exemption under paragraph 40(2)(b)of the Income Tax Act?
2. Do the log cabins (located on the 4.88 acre) in which the taxpayer lived for two years during the construction of a house close to the cabins qualify as a principal residence under the definition of this term in section 54 of the Act?
3. When the taxpayer, after moving from the cabins into the house, started renting the cabins, was there a deemed disposition of the cabins under subsection 45(1) of the Act?
4. Is the election under subsection 45(2) of the Act available in respect of the cabins?
Position:
1. Question of fact. Taxpayer referred to the TSO. General comments provided in respect of land in excess of 1/2 acre. Notwithstanding the existence of a minimum lot size restriction at acquisition, if severance could be obtained by application to authorities, the severable portion is not part of the residence: see section 16 of proposed IT-120R5. General comments also included for land of 1/2 acre or less because of the taxpayer's rough diagram locating the house at one end of the property (with road access), the taxpayer's statement that the "the house takes up some of the land where the cabins are", and the fact that the cabins are rented. Land used to earn income (from business or property) is generally considered not to be necessary for the use and enjoyment of the housing unit as a residence: see section 14 of proposed IT-120R5.
2. Yes, the cabins may qualify as a principal residence, if so designated.
3. Yes, a deemed disposition did occur.
4. Yes, the election under subsection 45(2) is available.
Reasons: IT-120R4 and proposed IT-120R5.
XXXXXXXXXX
Dear XXXXXXXXXX:
We are replying to your letter (undated) which we received on August 25, 1998, concerning the principal residence capital gain exemption.
You purchased a 4.88 acre property five years ago with two rustic log cabins on it. After living for two years in the cabins, with electricity but no running water or bathrooms, you moved into a house built on the west end of the property and started renting the two cabins to tourists, usually one or two weekends a months. Your water well is in the cabins’ area. At the east end of the property there is a corral and play pasture for a horse. The municipality will not allow land to be subdivided into parcels of less than three acres. As you are planning to sell the property, you would like to know what portion of the capital gain realized on the sale of the property would be taxable. In other words, your concern is how much of the 4.88 acre property qualifies as a principal residence for purposes of the principal residence capital gain exemption.
Whether of not a particular property constitutes a principal residence is a question of fact. As such determination requires a review of all the facts of the case, your local tax office is in a better position to provide you with assistance. For instance, as regards to your particular situation, it is unclear as to whether the subdivision restrictions were in place at the time of acquisition, whether both cabins were used as a principal residence simultaneously or whether the rental income from the cabins is ancillary to the main use of those properties when not being rented. It would also be helpful to know the respective fair market value of the relevant properties at the time of acquisition and at the present time. Nevertheless, we are prepared to offer the general comments set out below. You can find more information in the enclosed Interpretation Bulletin IT-120R4, Principal Residence.
The capital gain from the disposition of a principal residence is generally exempt from income taxation, as more fully explained in the bulletin. To the extent that a portion of a property does not qualify as being part of the principal residence, the related capital gain is not eligible for the principal residence exemption.
Under the definition of principal residence in the Income Tax Act, if the total area of the contiguous land upon which a housing unit is situated exceeds 1/2 hectare, the excess land is considered not to be part of the principal residence unless the client establishes that such excess land is necessary for the use and enjoyment of the housing unit as a residence. The onus is on the client to establish how much, if any, of the excess land is necessary for the use and enjoyment of the housing unit as a residence. Generally, an individual’s use of land in excess of 1/2 hectare in connection with a particular lifestyle does not, in itself, mean that the excess land is necessary for the use and enjoyment of the housing unit as a residence.
A minimum lot size and a severance restriction imposed by local municipal by-laws may be factors indicating that land in excess of 1/2 hectare may be required for the use and enjoyment of the housing unit as a residence. However, if it is feasible to sever part of the excess land, say by special application to the municipal authorities, this could be an indication that the severable excess land is not necessary for the use and enjoyment of the housing unit as a residence.
Where the housing unit is located on land not exceeding 1/2 hectare, usually the land qualifies as part of the principal residence, with no requirement to prove that it is necessary for the use and enjoyment of the housing unit as a residence. However, where part of the land is used to earn income, say, from a business, such part of the land is usually not regarded as needed for the use and enjoyment of the housing unit as a residence.
A cabin may qualify as a principal residence during the two years you lived in it, provided no other property is designated as a principal residence for those years, as explained in paragraph 6 of the bulletin. Both the house and a cabin may qualify as a principal residence for the year in which you moved into the nearby house. However, since for purposes of the principal residence exemption an individual can only designate one principal residence for any particular year, either the house or the cabin can be designated by you as a principal residence for the year of your move.
When there is a change in use of a property from personal use as a residence to income use as a rental property, special tax rules apply. Under the tax rules, the property would be considered to have been disposed of in the year of change in use for proceeds equal to its fair market value and to have been reacquired immediately after at a cost equal to the same amount. If the proceeds are greater than the property’s adjusted cost base, the deemed disposition results in a capital gain. The capital gain may be eligible for the principal residence exemption if the property qualifies for designation and is in fact designated as principal residence as indicated above. As explained in paragraph 31 of the bulletin, recognition of the capital gain can be deferred to a later year by electing under the provisions of subsection 45(2) of the Income Tax Act to be deemed not to have made the change in use of the property. While the election is to be made by means of a letter filed with the income tax return for the year in which the change in use occurs, it is the Department’s practice to accept a late-filed election provided that no capital cost allowance has been claimed on the property. A property may be designated as a principal residence for up to four years during which the mentioned election is in effect, subject to the restrictions explained in paragraph 32 of the bulletin.
As we indicated above, if you have specific questions regarding the tax implications from the sale of your property, we encourage you to contact the local tax office. We would be glad to provide assistance to the tax services office should they so request. We trust that the forgoing comments are of assistance to you.
Yours truly,
Jim Wilson
for Director
Business and Publications Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch
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