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A tax form that would stymie the best brains of NASA

My son, Win, and I were talking about what he wants to be when he grows up. "Dad, I think that working for NASA would be cool," he said. I suppose I should stop using the phrase "this is not rocket science, son" next time he asks for help with his homework. That implies rocket science is complex and I don't want him giving up on his career aspirations.

So, from now on, I'm going to say "this is not Form T2091, son." You might just have to file Form T2091 if you sold a property in 2011; it'll make rocket science look like first-grade math.

The rules

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The principal residence exemption is the exemption that can allow you to sell your home tax free. Each family unit (which includes you, your spouse or common-law partner, and children under 18) is entitled to designate one property as their principal residence for each tax year. So, if you own more than one property, you could end up paying some tax on one or both of those properties.

Whenever you sell a principal residence, start with the premise that you may have to file Form T2091 to tell the taxman about it, and that you may owe tax if you sold it for a profit. The truth is, you don't have to file the form if there's no taxable capital gain on the property. But, more people than realize it may have to file the form and pay some tax.

The story

Jack and Jill bought a city home in 1985 – call it "Home 1." They also bought a cottage in that same year. They sold Home 1 in 2000 and moved into a new home that year – call it "Home 2." Late in 2011, the couple sold their cottage for a sizable capital gain. Jack and Jill are filing their tax returns for 2011 and assumed that they wouldn't have to pay tax on the cottage sale. After all, a cottage can generally qualify as a principal residence.

Here's the issue: When they sold Home 1, they didn't pay any tax. Nor did they file any forms with the government. So far so good. Jack and Jill were entitled to designate Home 1 as their principal residence for the years 1985 through to 2000, and so the capital gain on the home was not taxable. Since there was no taxable capital gain, there was no requirement to file Form T2091.

But what about the cottage? Jack and Jill cannot designate the cottage as their principal residence for the years 1985 through 2011 because they had already, by default, designated Home 1 as their principal residence for many of those years. I say "by default" because they didn't file Form T2091 with the taxman to say otherwise when they sold Home 1. It's assumed, because taxes weren't paid on Home 1, that it was designated as their principal residence for every year it was owned. (Now, our tax law would not have required Jack and Jill to designate Home 1 for the years 1985 to 2000. They could have made that designation for 1985 through 1999 and still fully sheltered the home from tax due to the way our tax law works – you're given an extra year – a topic for another day.)

So, where does this leave the cottage? Jack and Jill can still designate it as their principal residence for the years 2000 through 2011 if they want. The cottage was owned for 26 years in total (1985 to 2011), but only 12 years (2000 through 2011 inclusive) of the 26 years can be sheltered from tax. The result? Jack and Jill will pay tax on part of the capital gain on the cottage.

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The form

So, Jack and Jill must file Form T2091 with their tax returns for 2011 because there's a taxable capital gain to be reported. Form T2091 calculates the exempt portion of the capital gain on the sale of a property.

The bottom line? If you have ever owned more than one property simultaneously, you should speak to a tax pro about your filing requirements for the year of any sale.

Tim Cestnick is president and CEO of WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians.

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