For those that don’t know and haven’t read the 340 comments on the last post: In general you have to pay capital gains tax on capital property when you sell it. The “gain” is the difference between the sale price and the purchase price (assuming it went up in value). For your principal residence, there is a capital gains exemption which means you don’t need to pay capital gains tax. However, if you are using property to produce revenue (i.e. rentals) then the exemption doesn’t apply and you have to pay capital gains tax again.
The issue under contention is that if you have a suite in your home, you are using part of the home to produce revenue which may trigger paying capital gains tax on the suite portion when you sell the home. We can safely say that the vast majority of Victoria owners have not historically paid capital gains when selling, but is that just because the CRA didn’t have the data to pursue them?
HHV reader CuriousCat analyzed historical CRA rulings and found a case that is relevant. CuriousCat is an accountant with 15 years experience and writes the following explanation:
Are basement apartments considered a taxable gain? This Tax Court of Canada case says Yes!
Many people are wondering these days, is my basement apartment considered a taxable gain when I go to sell? These people have been told, over and over by various sources, that as long as you didn’t claim capital cost allowance (CCA) or make structural changes to the property, or that the income was “ancillary” to its use as your principal residence, then they had nothing to worry about. They were told that less than 50% of the house used for rental was “safe”. But was this tested in a court of law? Actually it has.
In the July 16, 2009 Tax Court of Canada case of “Boulet v. The Queen” there are multiple issues being appealed, and the taxpayer was successful in winning all of them, except for the one regarding his principal residence. I believe the only reason the issue even came to light was because of the other issues being argued, and the auditor merely discovered the principal residence problem during the normal examination of his company. This is mainly due to the fact that up until 2016, CRA did not require people to report the sale of their homes; so many instances where people should have paid tax have gone undetected. CRA simply did not have all the information they needed to enforce the law.
Let’s look at the facts of this case. Mr. Boulet built a house on land he purchased from his company. The house had 3 floors including a basement. The basement was set up as an independent one-bedroom apartment with four and a half rooms (including a kitchenette and a bathroom). The basement was accessible from an exterior door and had its own municipal address: 183 Villandry Road. He lived on the two upper floors of the house. Occasionally, his children (who were then 16 and 17 and were in his custody on alternating weekends) used the basement “to watch TV”. In addition, during his testimony, Mr. Boulet called the basement a guest suite, without actually saying whether it had sometimes been used by his guests.
What is interesting, is that at no time did Mr. Boulet declare any rental income from the apartment, nor was CRA after him to determine if he had failed to report any rental income. As far as this case was concerned, the basement apartment was empty and unused. Yet it still was considered a taxable gain when he sold the house!
In addition, Mr. Boulet testified that he had made no efforts to obtain a separate municipal address for the basement….
- I didn’t make efforts to get a separate address. It’s really the town that told me, “Well, you can do that… you can put two addresses.” So, well…okay, I went with that, but I didn’t imagine that this implied that it might possibly mean it was a duplex or something like that.
When he put his house for sale, the MLS listing described the basement as a “bachelor apartment.” When the house was sold for $330,000 and no capital gain was reported on his 2002 tax return, CRA computed a capital gain upon the sale of the basement based on the fact that the top two floors were 1,800 square feet and the basement apartment was 900 square feet. In this case, the basement apartment was only 33% of the total square footage of the house, below the 50% believed by some people to be the “magic number”.
The decision included the following:
Section 54 of the Act defines “principal residence” as follows:
“principal residence” of a taxpayer for a taxation year means a particular property that is a housing unit, a leasehold interest in a housing unit or a share of the capital stock of a co-operative housing corporation acquired for the sole purpose of acquiring the right to inhabit a housing unit owned by the corporation and that is owned, whether jointly with another person or otherwise, in the year by the taxpayer, if
(a) where the taxpayer is an individual other than a personal trust, the housing unit was ordinarily inhabited in the year by the taxpayer, by the taxpayer’s spouse or common-law partner or former spouse or common- law partner or by a child of the taxpayer,
Since the Act does not define the word “housing unit”, the judge used two dictionaries:
. . . 2. Premises used for living; a part of a house or building in which someone ordinarily resides.
A unit that provides therein living, sleeping, eating, food preparation and sanitary facilities for one or more persons, with or without essential facilities shared with other housing units.
In this case the basement apartment was considered a separate housing unit. It had 4.5 rooms, including a kitchenette, a bedroom and a bathroom. It was noted the basement was accessible only through an exterior door. The taxpayer had to bring evidence that he ordinarily inhabited not only the two upper floors, but the basement as well. The only evidence supplied by Mr. Boulet in this regard was his testimony that his kids sometimes used the basement to watch TV.
“The evidence clearly shows is that Mr. Boulet did not ordinarily inhabit the basement during the 2002 taxation year. Consequently, Mr. Boulet could not claim the principal residence exemption in respect of the basement of the Residence when the residence was sold in 2002.”
In deciding to apply the gross negligence penalty on the unreported taxable capital gain (which is equal to 100% of the income not reported), the judge took into account the fact that Mr. Boulet built the house so that it would have two separate housing units and sold it on the basis that it had two separate housing units. He found it more probable than not that Mr. Boulet was aware, not only of his duty to report the capital gain from the sale of the house, but also that he was not entitled to the principal residence exemption in respect of the basement, because he never ordinarily inhabited that basement.
“When he was questioned by the Minister about that occupancy, he quite simply tried to get the Minister to believe that he did not report the capital gain because he thought that a taxpayer did not have to report taxable gains from the sale of a residence that he ordinarily inhabited, since that capital gain was exempt in any event.”
Bottom line, the judge believed the taxpayer was trying to avoid paying taxes and intended to omit reporting the sale. The penalty was allowed. In the end, the taxpayer had to include an additional $12,449 to his net income for the year 2002. Assuming his tax rate was 40%, he would have paid an additional $4,980 at the time of filing his taxes. Instead, since this didn’t go to court until 2006 and the appeal wasn’t heard until 2009, there is an additional six years of interest owing on that $4,980 (which amounts to about $3000) PLUS the penalty of $12,449 (plus interest of about $6300). Mr. Boulet’s tax bill is now $26,500 instead of the $4,980 he could have paid.
Now that CRA has changed the reporting requirements, no more feigning ignorance. As this Globe and Mail article states, “The onus is going to be on you to understand the principal residence rules… even if you haven’t sold your residence, you might be deemed to have sold the place in certain situations (if you change all or part of your residence to or from a rental or business operation, as an example), which will require you to report to CRA just the same.”
Huge thanks to CuriousCat for digging this up and translating and analyzing it. So does this put the issue to bed? Will you for sure have to pay capital gains on your suite (which makes renting suites in an appreciating market a money losing proposition)?
Mr. Boulet’s suite had a separate address and no internal access, however it seems pretty clear from the judge’s comments that what matters is that the space was not in regular use by the owners and that is definitely the case for our common suites.
Should we still pursue a CRA ruling?