I have a friend who is engaged to be married. Both he and his fiancée own their own homes and are concerned about the tax implications on the sale of the properties once they are married. Right now, each property is considered their respective principal residence and not subject to tax if sold. Does the status change once they get married, since they would then then own two residences? Do they have to sell one of the homes before getting married to avoid capital gains tax?
Your question is a good one. Our tax law does say that a “family unit” can designate just one residence as their principal residence in order to shelter it fully or partially from tax. A family unit is defined to include spouses (married or common-law) and any minor children. To answer your question, it’s important to understand how the principal residence exemption (PRE) works.
For each calendar year you are entitled to designate one particular property as your principal residence. So for example, suppose you purchase two properties in 2002. If you own two properties from 2002 to 2012 and then you sell one in 2012, you have the option of designating the property that you have sold as your principal residence for all or some of those ten years. If you designate the property you’ve sold as your principal residence for all ten of those years, you will fully shelter it from any capital gain tax on the sale.
The actual formula for determining the proportion of the capital gain that is sheltered looks like this: Number of years you designate the property as your principal residence, plus 1, divided by the total number of years the property was owned. Note the “plus 1” in the formula; this allows a family unit to own two properties at the same time for up to one year and still shelter both properties fully from tax. That is, there can be an overlap by one year when owning two properties.
Back to your friend’s situation: For the taxation years before the year of marriage and including the year of marriage, both individuals would be able to claim their respective residences as their principal residence. However, in the taxation years subsequent to the year of marriage, the two individuals would be spouses throughout the year and therefore, only one property may be designated as their principal residence for a particular year. So, they don’t need to sell a residence before marriage, but if they want to fully shelter both properties from tax they’ll have to sell one no later than the tax year in which they get married.
With tax season is full swing, Globe Investor columnist Tim Cestnick is answering one reader question online each week in the runup to the filing deadline. Mr. Cestnick is president and CEO of WaterStreet Family Offices and author of 101 Tax Secrets for Canadians.
Please note that Mr. Cestnick will not be answering detailed questions about a person's individual tax returns. Preference will be given to questions with a broader scope.
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