Primary residence vs. secondary residence
The tax treatment of real estate in Canada will depend on its use. The home you reside in – your primary residence – is frequently exempt from capital gains tax if you sell it due to primary residence exemption.
This exemption may even be used for vacation properties, so long as they’re “normally occupied.” The definition of “normally occupied” is vague, but it surely means you’ve gotten lived there for no less than one calendar 12 months. And while there may be an exception for years during which you progress and own two homes, otherwise you may only ever declare one property as your primary residence. Generally, it is best to apply the exemption to the property that has increased in value probably the most.
Rental properties don’t qualify for this exemption most often. If they’re sold and their value has increased, capital gains tax is frequently payable.
Capital gains tax on a second property in Canada
If you can not use the first residence exemption when selling a property, capital gains tax can be levied on the rise in value. However, capital gains taxes are relatively tax efficient as only half of the gain is taxable – the opposite half you may put in your jeans.
To calculate capital gain, you need to first determine the adjusted cost basis (ACB), against which the sale proceeds are measured. The start line is the acquisition price, and from there certain additions and deductions may be made. Common additions include costs incurred in purchasing the property, akin to commissions and legal fees. Capital costs, akin to those used to enhance or add value to the property, may also be added.
This is where it gets just a little more complicated. Because a constructing is depreciable property that may wear out over time, investors can deduct a percentage of the fee of the property annually – called the “capital cost allowance” (CCA). It can only be used on the constructing itself, not the land portion of the property. When the property is eventually sold, the undepreciated capital cost (UCC) – that’s, the unique cost minus the CCA amount claimed – is reclaimed and taxed as income, while any additional proceeds are taxed as capital gains.
As a simplified example, for instance you bought a rental property for $1,000,000. Over the years, you deducted $200,000 in CCA. You then sold the property for $1,300,000. Here’s how the property can be taxed:
- Original cost: $1,000,000
- CCA demanded: $200,000
- Unamortized capital costs: $800,000
When the rental property is sold, that $200,000 CCA is reclaimed and taxed as income. And because you sold it for $1,300,000, you’ve gotten a capital gain of $300,000. Capital gains inclusion rates have recently modified in Canada. Effective June 25, 2024, 50% of the primary $250,000 of capital gains earned in a calendar 12 months should be included as income. And for any capital gains above that quantity, two-thirds (66.67%) can be included as income. In our example, that involves $158,333.33 added to your income (($250,000 x 50%) + ($50,000 x 66.67%)). Between the refund and the taxable capital gain, you’ve gotten $358,333.33 in income to report in your tax return.
Capital expenditure vs. current expenditure: what is the difference?
In the instance above, the fee of improving the property is a capital cost. It extends the useful lifetime of the property or increases its value. Capital costs can increase the ACB of the property and may be deducted over time through the CCA. Examples include:
