Donald and Helen have been friends for many years.
"Tim, we've finally decided to sell our home in Oakville and move to the cottage in Muskoka," Don said.
"But Don, I thought that Helen refused to move up north full time," I responded.
"I was against it," Helen said, "but he convinced me. He's always been a good salesman you know."
Helen is right. Don is a good salesman. "Don, when did you first realize you could sell anything?" I asked.
"It goes back to my days as a shower curtain ring salesman. Sales were slow so I took my wares to the Home Show and convinced one teenager that they were the newest thing in earrings. I convinced a man that they were fishing bobs and woman that they were Christmas tree ornaments. So, we're moving in July. We want to put our home up for sale this summer. Got any tax advice?" "Don, I'm glad you asked," I replied.
Since 1982 Canadian tax law has allowed each family unit (which includes you, your spouse or common-law partner, and unmarried kids under 18) to designate one property as their principal residence (PR) per year. The benefit? A portion, if not all, of the gain on the sale of that property can be sheltered from tax using the PR exemption.
Things were different prior to 1982 when each individual was entitled to his or her own exemption, regardless of any exemption claimed by a family member. As a result, it was possible for a couple to shelter the tax on two different PRs for years prior to 1982.
To claim the exemption, you must designate one of the properties that you own as your PR on a year-by-year basis. For example, if you owned a city home for 15 years and you designated that home as your PR for each of the 15 years, you would fully shelter any gain on a sale from tax. If you designated a different property for some of those years, and the city home for the balance of the 15 years, you may only shelter a portion of any gain from tax. (You make the designation in the year of sale by filing Form T2091 with your tax return.)
By the way, any property that is "ordinarily inhabited" during a year can be designated as the PR for that year -- which generally includes a cottage.
Back to Don and Helen. They purchased their home in Oakville, Ont., back in 1974 and their cottage the same year. Both properties have been jointly owned by Don and Helen since they were acquired. The home has appreciated in value a little more than the cottage.
Remember, Don is entitled to designate one property as his PR for each year prior to 1982. In addition, Helen is able to designate one property as her PR for each year prior to 1982. Finally, Don and Helen together can designate one property for the years after 1981.
If the couple failed to take the best tax planning steps possible, here's what they could do: Don could shelter his half of the city home from tax by designating that home as his PR for the years prior to 1982. Helen would also have to designate the home as her PR for the years prior to 1982 in order to shelter her half of the home from tax. For years after 1981, only one exemption is available and they would designate the city home for those years. The result? No tax on the sale of the city home.
Here's a better way: Don and Helen could separate the ownership of the two properties today by changing title so that Don owns one property and Helen owns the other. The taxman will now consider each spouse to have owned each property individually (not jointly) from the day they were acquired by the title change.
Suppose that Don now owns the city home. Don could shelter the city home from tax by designating that home as his PR for the years prior to 1982. For years after 1981, only one exemption is available and the couple would designate the city home for those years.
The result is twofold: There is no tax to pay on the sale of the city home since it has been designated as a PR for every year it was owned. Further, Helen has not yet designated a property as her PR for the years prior to 1982. She could designate the cottage for those years. The result? We've now sheltered part of the eventual gain on the cottage as well.
A little idea worth some big bucks.
Tim Cestnick, CA, CFP, TEP is author of Winning the Tax Game 2002 and Winning the Estate Planning Game. He is managing director, Tax Smart Services, at AIC Ltd.
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