Preventing a Home Sale Tax Hit
Before you start investing in real estate, learn how home sales are taxed, including how to calculate capital gains and when you might be exempt from paying it altogether.
By Emily Southey | 13 minute read
If you’re a real estate investor, understanding Canada’s tax system is crucial. Many types of home sales are taxed in Canada, including rental properties, so it’s important to know what these taxes are so you can learn how to legally avoid a home sale tax hit.
Taxing Home Sales in Canada
Not all home sales are subject to taxes in Canada, but some are. The properties that are taxed are most often investment properties or second homes, both of which might be subject to capital gains tax. To help you determine whether your investment property will be taxed when you sell it, we define capital gains tax and break down the key differences between selling a principal residence and selling a rental property below.
Capital Gains Tax Home Sale in Canada
Depending on the designation of your home, the sale of your property might be subject to a specific type of tax known as capital gains tax. Capital gains tax is a type of tax that may be owed to the federal government when you profit from the sale of an investment property. (Please note that capital gains tax is also applicable on the sale of other major assets, such as stocks and bonds). Investors only owe capital gains tax if they earn more from the sale than they originally paid, and the capital gain they owe relates to the amount of profit earned. On the flip side, investors do not owe money if they sell the property at a loss, which is known as a capital loss. To put this into perspective, if you are an investor who bought a rental property for $800,000 and then sold it for $975,000 five years later, your capital gain is roughly $175,000 (the difference between the sale price and the original purchase price).
Selling your principal residence
In most cases, when you sell your home you do not have to pay tax on any money you gain from the sale. This is due to the principal residence exemption, which we will outline in more detail below. Generally speaking, as long as the home was your principal residence for every year that you owned it, the home sale will not be subject to capital gains tax.
Despite the fact that you will not have to pay capital gains tax, you must still report the sale of a principal residence. Specifically, you must report the sale on Schedule 3, Capital Gains (or Losses), and complete page 1 of Form T2091, as long as the property you sold was your principal residence for all the years you owned, or for all but one year (the year you replaced it).
Please note that as of 2016, the Canada Revenue Agency (CRA) only allows an individual to claim the principal residence exemption if they report the disposition and designation of the principal residence on their income tax and benefit return. If you fail to make this designation for the tax year of the sale, you must contact the CRA as soon as possible to amend your income tax return for that year.
“Depending on the designation of your home, the sale of your property might be subject to a specific type of tax known as capital gains tax. Capital gains tax is a type of tax that may be owed to the federal government when you profit from the sale of an investment property.”
Selling your rental property
While selling a principal residence typically exempts you from a home sale tax, this is not the case with rental or investment properties. Any time you sell a rental property for more than you originally paid, you have a capital gain. This capital gain is then subject to tax. The sale of any property that is not a primary residence — whether it’s a rental property or a second home, such as a cottage, is subject to capital gains tax if the owner profits from the sale.
When filing your taxes for the year that you sold your rental property, you will need to list it on Schedule 3, Capital Gains (or Losses), just as you would for a principal residence. Use Schedule 3 to calculate how much capital gains you owe (visit the CRA’s Guide T4037, Capital Gains, for more information on calculating capital gains tax), and from there, transfer 50% of the total to line 12700 of your tax return (this is your taxable capital gain amount).
How Much Tax Do You Pay on the Sale of a House?
Now that you understand under which circumstances you might owe capital gains tax, let’s consider how much tax you will pay on a property sale. Capital gains tax in Canada is closely tied to income tax. Therefore, how capital gains tax works is not as black and white as HST or GST. When you earn a profit from the sale of a rental property, 50% of that profit will be subject to capital gains tax. In essence, only half the profit you earn from the home sale is taxable; the other half is for you to keep tax-free. However, calculating profit isn’t always as simple as deducting the original purchase price from the sale price. This is because the CRA lets you claim expenses related to the property, as well as expenses related to the original purchase, which can reduce your profits and therefore the amount of money that is taxed.
So how do you calculate a capital gain (or loss) on a recent property sale? According to the CRA, there are three components to calculating capital gains:
- The proceeds of disposition: Otherwise known as the sale price of the investment property, and the amount you received for the property;
- Adjustment cost base (ACB): The ACB is the price you originally paid for the property, plus the expenses paid to acquire it, such as legal fees; and
- Expenses incurred to sell the property: You can deduct certain expenses associated with selling your property from your capital gain. These expenses include legal fees, update or renovation fees, finder’s fees, commissions, brokers’ fees, surveyors’ fees, advertising costs, and transfer taxes.
Once you’ve calculated your true capital gain, you must then divide this number in half and the amount you are left with is the amount subject to capital gains tax in Canada. This amount must then be added to your next income tax return. Since capital gains tax is not only tied to the amount of profit earned but also a person’s personal income, the exact amount owed varies significantly from person to person.
How to Prevent a Canada Home Sale Tax
Unless you qualify for a capital gains exemption, it is impossible to legally avoid a Canada home sale tax. However, there are some tips and tricks, including a few CRA rules, that you can take advantage of to reduce the amount of money you owe. Check them out below.
1. Qualify for a capital gains exemption
If you want to avoid a home sale tax in Canada, your best bet is to qualify for a capital gains exemption. The exemptions are as follows:
Principal residence exemption
The principal residence exemption is the main capital gains exemption in Canada. In essence, when you sell your primary residence, any profit you make will not be subject to capital gains. As long as your home meets the CRA’s criteria (see below), you will qualify for this exemption:
- It is a housing unit, a leasehold interest in a housing unit, or a share of the capital stock of a cooperative housing corporation you acquire only to get the right to inhabit a housing unit owned by that corporation;
- You own the property alone or jointly with another person;
- You, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year; and
- You designate the property as your principal residence.
Farming and fishing property exemption
The farm and fishing properties exemption is another capital gains exemption. This one is a little more niche as the property sold must have been a farm or fishing property that meets the criteria below. It’s worth noting that there is a lifetime limit of $1 million on the farming and fishing property exemption.
- Shares of the capital stock of a family-farm or fishing corporation owned by you, your spouse, or your common-law partner;
- An interest in a family-farm or fishing partnership owned by you, your spouse, or your common-law partner;
- Real property including land, buildings, and fishing vessels; and
- Property included in capital cost allowance Class 14.1, such as milk and egg quotas, or fishing licences
Capital gains tax exemption on property donated to eligible organizations
Donating real estate to a charity may also allow you to qualify for a capital gains exemption. If you donate eligible property to a registered charity or other organization, you may be exempt from paying capital gains tax on any gains realized. Please note that qualified donees in Canada only include the following:
- Registered charities;
- Registered amateur athletic associations;
- Registered municipalities; and
- Registered national arts service organizations.
To take advantage of this exemption, you will still need to report any capital gains or losses on Schedule 3, and you will need to complete a separate form entitled Capital Gains on Gifts of Certain Capital Property.
2. Wait to sell the property until your income is at its lowest
Since the amount of capital gains tax you will pay depends on your tax bracket, it might be smart to wait until your income is at its lowest to sell the property. While this only works for investors with fluctuating income levels, it can be an effective method of reducing how much income tax you pay. For example, if you or your spouse is taking a leave of absence from work, whether in the form of a sabbatical or parental leave, and your salary will be reduced for a certain time period, this could be the ideal time to sell your property if you want to prevent a major tax hit.
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3. Gift your property to a family member or spouse
Gifting your property to a family member or spouse can also reduce how much capital gains you owe. To benefit, you can transfer the capital property to your spouse or another family member in a lower income tax bracket. This way, they will pay a lower capital gains tax and the overall amount of capital gains tax your family pays will be reduced. Another option in this vein is to gift a capital asset that would be a loss to a family member. Gifts of capital property are taxed according to their fair market value price, which would allow you to claim the capital loss while keeping the property within your family.
4. Leverage capital losses to offset capital gains
The CRA allows individuals to offset their capital gains with capital losses. Therefore, if you suffered a capital loss in the past three years (it doesn’t need to have been in the same year you earned a capital gain), you could leverage it to reduce how much capital gains tax you pay. It’s worth noting that your capital loss doesn’t have to have been on another piece of real estate, it could also be for a stock or bond you sold for less than you originally paid. Capital losses from the past three years can be applied to capital gains, so if you don’t have a capital gain in the same year you suffered a loss, it might be worthwhile to hold onto it and retroactively apply it to a future capital gain.
5. Hold real estate investments in a TFSA or RRSP
One final way to legally avoid a major home sale tax hit in Canada is to hold your investments in tax-advantaged accounts. Examples of tax-advantaged accounts in Canada are the Tax-Free Savings Account (TFSA), Registered Retirement Savings Plan (RRSP), and Registered Education Savings Plan (RESP). These are all registered accounts, which are your best bet for minimizing the taxes you owe on investments. TFSAs and RESPs are tax-free accounts, while the RRSP is a tax-deferred account. Holding your investment property in one of these accounts can give you a major advantage come tax time.
Frequently Asked Questions
How are capital gains calculated? How are they taxed?
Capital gains are calculated by subtracting the adjusted base cost (ABC) of the property from the sale price of the property (net of fees). To calculate the adjusted base cost, you will need to deduct the expenses incurred to acquire it (for example, legal fees) from the purchase price. Meanwhile, the sale price of the property is not simply the amount you sold the property for, but this amount less the expenses incurred to sell the property (legal fees, brokers’ fees, surveyors’ fees, and more).
Only 50% of the total realized capital gain is taxable in Canada. This amount is added to your annual taxable income and taxed at your marginal tax rate. Therefore, to determine how much tax you will have to pay on your capital gain, you will need to consult the tax rates in your province for your income bracket.
Are all real estate profits taxed at the same rate?
If you do not qualify for a capital gains exemption, then 50% of your real estate profits will be subject to capital gains tax. Keep in mind that this translates to 50% of your realized capital gain (once the adjusted base cost and other expenses are accounted for). Half of your realized profits from the home sale will be added to your income. From there, the rate at which you are taxed depends on which province and territory you live in and your income level. In addition, rental income is taxed as ordinary income in Canada, according to the tax rate in your jurisdiction.
How long do I have to keep a property to avoid capital gains tax?
The CRA does not currently have any rules about the amount of time someone must keep a property to be eligible for the principal residence exemption. However, if the property being sold was not a principal residence, it will be subject to capital gains tax no matter how long you owned it. Further, starting on January 1, 2023, any profit from the sale of a residential property will be taxable as business income, as long as the seller owns the property for less than a year. This new rule was introduced in the 2022 federal budget and is aimed at cracking down on the practice of house flipping.
Do I have to buy another house to avoid capital gains?
No, buying another house will not help you avoid capital gains. If you are selling a property that is not a principal residence, the sale will be subject to capital gains tax.
What is the capital gains exemption?
There are a few types of capital gains exemptions, including the principal residence exemption, the farm or fishing property exemption (also known as the lifetime capital gains exemption), or the donated property exemption. Sales of principal residences are tax-exempt in Canada, and the CRA clearly defines what constitutes a principal residence (all four of the below criterion must be met):
A housing unit, a leasehold interest in a housing unit, or a share of the capital stock of a co-operative housing corporation you acquire only to get the right to inhabit a housing unit owned by that corporation;
You own the property alone or jointly with another person;
You, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year; and
You designate the property as your principal residence.
Meanwhile, there is also a farming and fishing property exemption, meaning the sale of a farm or fishing property is also exempt from capital gains tax (up to a limit of $1 million). Finally, your home sale may also be exempt from capital gains tax if the property is donated to an eligible charity or organization.
At what age do I not pay capital gains?
Current tax law in Canada does not exempt individuals from paying capital gains tax on a home sale due to their age. The only way to avoid paying capital gains tax is by qualifying for an exemption, such as the primary residence exemption.