I've been teaching my kids about the value of owning real estate and my kids are taking it to heart. My daughter just convinced her younger brother to co-invest in a piece of real estate, then flip it for a profit. Where's the property? Our backyard.
You see, we have a great play set in our yard with a sandbox, swings and a clubhouse. My kids sold the right to use the play set to our neighbour's kid for $10 for the summer. So, I told my kids they have to pay tax on their profit. I became the tax collector, levied a $10 tax, then made a transfer payment back to our neighbour. My kids are learning about taxation the hard way.
Others have learned tough tax lessons about selling real estate as well. Most people assume the sale of a principal residence is always tax-free. Not necessarily. Let me explain.
The story of Wayne Cassidy is a helpful one. Mr. Cassidy had acquired a property near London, Ont., in 1994 that was 2.43 hectares in size (about six acres). When he purchased the property, the applicable zoning laws would not allow him to purchase a property smaller than this. The laws remained this way until May, 2003, when it became possible to subdivide the land into smaller parcels.
Mr. Cassidy lived on the property from the time he purchased it until he sold it in 2003. A property developer had made an offer to buy his land subject to the successful rezoning of the property.
The rezoning was completed and the property was sold in November of that year for a profit. Mr. Cassidy did not report the capital gain on his tax return since he considered the property to be his principal residence, sheltered from tax using the principal residence exemption (PRE).
In a nutshell, our tax law says that an exemption is available to shelter all or part of the sale of a principal residence from tax. But our tax law defines a principal residence to include a housing unit and up to just half a hectare (about 1.25 acres) of immediately contiguous land. The definition excludes land in excess of half a hectare unless you can show that the excess was required for the use and enjoyment of the housing unit as a residence.
So, herein lies the problem: Mr. Cassidy's property was larger than half a hectare. The taxman took the view that the capital gain on the excess land should not be sheltered from tax using the PRE. Mr. Cassidy took the taxman to court over the issue. He argued that he was required to purchase the full 2.43 hectares – he had no option to buy less land, so the full property was required for his use and enjoyment of the home as his residence.
The taxman argued that, on the date he sold the property, Mr. Cassidy no longer required the excess land for his use and enjoyment since the zoning laws had changed. Canada Revenue Agency argued that it's the status of the property on the date the land was sold that matters – not the status on the date the property was acquired, or during the years he owned the property. The Tax Court of Canada (TCC) sided with the government and Mr. Cassidy lost his case.
Mr. Cassidy took his case to the Federal Court of Appeal (FCA). Fortunately, saner heads prevailed. The FCA ruled that one must consider the entire length of time Mr. Cassidy owned the property. During almost the entire time he lived in the home, Mr. Cassidy had no option but to own that much land if he wanted to reside there. The excess land was required for his use and enjoyment of the home as his residence. It was only in the last few months of his ownership that he was entitled to subdivide his property.
There are some lessons here: First, if you own more than half a hectare of land around your residence because of zoning laws that are still in place, you may still claim the PRE. If those laws change, you may shelter part of the gain on a sale later, but could face some tax on part of the gain attributable to the excess land. Finally, if you have a large property, consider structuring the layout of your property so that you can argue that the full property is necessary for the use and enjoyment of the home as your residence. See my article dated May 19, 2011, at waterstreet.ca for more on this last idea.