Another Court Case of Principal Residence Exemption Gone Wrong

Recently, we’ve got friends and families approaching us for advice on real estate investing.

One of our closest relatives, a couple of two high income individuals each earning over 6 figures, asked us where they could go next.

They currently live in downtown Toronto in a 1+1 condo.

Even though their condo appreciated, it didn’t appreciate at the same rate as a detached home.

They are now finding the 1+1 condo too small for their needs.

For the area that they prefer to move to, they could afford the place with the sale of their current property.

But they are concerned about a crash in the housing market.

Alternatively, they could choose to invest in a rental property instead, wait a few years for appreciation, sell their investment and purchase their dream home down the road.

There’s virtually no perfect answer to their situation.

I wrote a blog post previously about advice that I would give myself when I was back in my 20s. If I had a choice, I would live in a less expensive city and raise my family there.

The real estate market in downtown Toronto and Richmond Hill/Markham has gone up so much that it is almost impossible to purchase a house there, even with over $200K of solid employment income coming in.

As much as I believe that principal residence is the biggest tax free asset you can get in Canada, I am almost hesitant to tell them to get their house now. ☹

Who can guarantee that there’s no market correction coming up?

But buying investment properties is different.

Another close friend asked me about buying pre-construction stacked townhomes in Bowmanville. Her intention was to flip it as the builders allow assignment.

I told her I didn’t know Bowmanville very well but I know that it’s a nice town.

And I also told her that what she planned to do is speculation while my investment strategy is always long term buy and hold.

I only buy properties that have enough rental income to cover the expenses and I don’t have to put extra money into it on a monthly basis.

Market goes up, I’m happy.

Market goes down, I’m not too concerned.

My advice to her is that I would go ahead to firm up the deal if rent can cover all the expenses.

Now on to this week’s topic –

There’s a recent court case that came out February 16, 2017 about principal residence exemption and I thought it would be interesting to share with you.

The taxpayer purchased a preconstruction condo, 560 square feet, on Yonge Street February 2007. He took possession May 11, 2009 and closed November 2009 and subsequently sold the property January 2010.

The taxpayer’s wife was the listing agent who sold the property.

The taxpayer never reported any rental income from the property.

The taxpayer’s CRA account was not changed to the subject property.

The taxpayer didn’t report the sale in his tax return, on the basis that he was living in the property and believed that the profit he made on this property was exempted from tax.

To qualify to claim principal residence exemption, you must ordinarily inhabit the property during that period. The onus is on the taxpayer to prove that he lived in the property.

Evidence can range from simple change of address of your driver license, you CRA account, your bank statements and the utilities bills. Evidence can also include pictures of your kids’ birthday parties.

Evidence also includes the preliminary questionnaire that CRA asked the client to answer in the initial audit.

Here are the 3 factors that led the judge to conclude that the taxpayer did not live in the property –

1. The taxpayer was asked in the CRA questionnaire whether he lived in the property and his answer was “no”. And he was also asked the name and ages of people who resided with him and he left the answer blank.The judge’s take was that if he did live in the property as he claimed, he would not have a problem answering yes and he should be able to list out all the people who lived with him at the time.

2. The listing for sale showed that the property was tenant occupied.Taxpayer suggested to the court that it was a mistake but given that the listing agent was the taxpayer’s wife herself, the judge believed that it’s unlikely that such a mistake would be made.

   If there was a tenant, then the family could not have occupied the unit at the time.

   Hence, no principal residence exemption allowed.

3. Two electricity bills were supplied dated September 2009 and January 2010. Both bills were headed with “Final Bill”.September bill covered the period from initial occupancy date to July 2009. January bill covered the period from December 31 to January 12, 2010.

   Based on the information on the January bill, the section that says “amount of last bill” was identical to the bill from September bill and the usage from prior period matched the first bill in September as well.

   The Judge concluded that the taxpayer did not occupy the unit from July to December 2009.

   Hence, no principal residence exemption allowed.

While principal residence is the largest tax free asset allowed in Canada, I always advise my client not to abuse it. If your intention is to move into the property, all evidence must corroborate with your intention.

If your intention is to flip the property, flip it inside a corporation and enjoy the 15% tax rate.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your real Estate accountant