Save taxes on your residential real estate

Home owners can realize tax gains when they know the rules.

Residential real estate in Edmonton is hot, hot, hot! If you seek your fortune in the market the taxman wants his share. Here are some important points to keep in mind when investing in residential real estate.

The principal residence exemption is a significant benefit available to homeowners. It’s intended to allow all the proceeds from the sale of your home to be used to purchase another one. Like most tax provisions, however, the rules are filled with traps.

For tax purposes, “principal residence” is essentially a home owned and “ordinarily inhabited” by the taxpayer, his or her current or former spouse (includes common-law), or their children.

It’s not uncommon to own more than one property that could qualify as a principal residence. Many families, for example, own a home and a cottage. You don’t need to live year round at the cottage to “ordinarily inhabit” it.

The good news is you don’t need to decide which property to designate as your principal residence until the property is sold and you sit down to do your taxes. The bad news is, once you’ve sold your home and designated it as your principal residence for any year, no other property can be designated as your principal residence for those same years. Thus, you need to compare the anticipated sale dates and expected gain on each property before deciding which one to designate as your principal residence for any particular year.

Due to the way principal residence exemptions are calculated, home sale gains are deemed to accrue equally over the total years of ownership. This also has to be considered when deciding which property to designate as your principal residence.

If your home sits on large parcel of land, issues arise as to how much land is included under your principal residence exemption. As a general rule, land beyond ½ hectare is included only under special circumstances. This rule is of particular concern to acreage owners and farmers.

To claim your exemption you have to report your gain from the sale of your home on your income tax return and file a special form. But not all home sales are eligible for exemption. If your gain is regarded as income, it will be taxed as income not as a capital gain, and the exemption will not apply. This can happen when a home is “flipped” (purchased just to fix up and sell for profit).

In Alberta, the top combined marginal tax rate on income is 39 per cent. Capital gains, on the other hand, are taxed at the top marginal rate of 19.5 per cent.

Taxpayers are often unaware of the “change-of –use” rules which apply when a property changes from personal use to business use or vice versa. Tax rules regard this as simultaneously disposing of, then reacquiring the property, at market value. This applies when your home (or part thereof) becomes a rental property, or your rental property becomes your home. The home will not normally qualify as your principal residence for any year in which it was a rental property.

When it comes to realizing a gain on your residential real estate, knowing what to expect from the taxman makes all the difference.