Last weekend my wife, Carolyn, was out in the yard planting new gardens. Our youngest son was with her, digging a hole in the corner of the yard that was a foot wide and about three feet deep. "Dad, did you know that if you dig deep enough you'll reach the centre of the Earth – and it's really hot there."
"Is that what you're doing?" I asked.
"Dad, c'mon, don't you know that the Soviets tried that already, a long time ago. They dug a hole 12 kilometres deep and hit lava. They had to stop. I'm just digging a hole to burry Chester, then I'm going to plant a tree over the spot so we remember him."
Chester is our hamster, who died a few days ago (Chester is also the name of a family friend – whom we did not bury – just to clarify). With all the landscaping going on at our home, and in our neighbourhood, it reminded me of an idea you should keep in mind if you own a larger property and want to save tax. Let me explain.
I'm sure that you're aware of the rule in our tax law that can allow you to sell your principal residence on a tax-free basis. There's an exemption available, called the principal residence exemption (PRE). There are many types of properties that can qualify for the PRE, including a house, apartment or unit in a duplex, an apartment building or condominium, cottage, mobile home, trailer, or houseboat, among other less common properties.
To be entitled to the exemption, the property must be ordinarily inhabited by you, your spouse or common-law partner, former spouse or common-law partner, or a child of yours. Although there's no hard and fast rule around what it means to "ordinarily inhabit" a property, the taxman has said that living there for even a short time in the year (during your vacation time, for example) should be fine.
Sorry, but if the main reason for owning the property is to produce income – as with most rental properties – you won't be entitled to shelter a capital gain on the property from tax using the PRE. Our tax law also restricts the amount of land that can qualify as part of your principal residence. If your property is more than half a hectare (about 1.25 acres) in size, then the excess over this amount is not considered to be part of your principal residence and generally can't be sheltered from tax using the PRE. But there's an exception. If you can show that the excess land is necessary for the use and enjoyment of the property as a residence, the excess may still qualify for the PRE.
The taxman gives some examples where excess land may be "necessary" for your use and enjoyment of the property as a residence. Visit cra.gc.ca and check out Income Tax Folio (ITF) S1-F3-C2, Principal Residence. It reads: "Land in excess of one-half hectare may be considered necessary where the size or character of a housing unit together with its location on the lot make such excess land essential to its use and enjoyment as a residence, or where the location of a housing unit requires such excess land in order to provide its occupants with access to and from public roads."
The way in which you lay out your property, then, could save you tax dollars. Consider Chester (our friend, not the hamster) and William. The two men have identical properties, both larger than half a hectare. Chester locates his residence near the front of his property with a short driveway to the road and has little behind his house except some bushes and shrubs. It's not likely that Chester's land in excess of a half-hectare will qualify for the PRE.
William, on the other hand, set his home back from the road further, and his driveway is much longer. He has a pool in the backyard which is set back from the residence. William occupies more of his property than Chester. It would be easy for William to argue that a much larger portion of his property is necessary for the use and enjoyment of his house as a principal residence, including the portion of land on which his driveway sits, providing access to public roads.
You'd be wise to read through ITF S1-F3-C2 and visit a tax pro to talk over your plans before entirely redesigning your property. It's good to know, however, that some proper planning could save you big tax dollars.