New Tax Reporting Rules for Principal Residence Sales

The battle against perceived rampant real estate speculation continued when, on October 3, 2016, Canadian Finance Minister Bill Morneau released income tax amendments designed to “close loopholes” in the Income Tax Act related to the housing market. A relatively innocuous new reporting rule caught my eye.

It has long been accepted wisdom across Canada that a homeowner selling his or her “principal residence” did not have to report anything on their tax return for the year of disposition. While the Income Tax Act requires the disposition of every capital property to be reported on one’s tax return, including principal residences, the longstanding administrative position of the Canada Revenue Agency (CRA) was far more lenient in allowing taxpayers to not report the sale – at all – as long as the entire gain was sheltered by the principal residence exemption.

That era has come to an end with the October 3 Notice of Ways and Means Motion. For taxation years ending on or after October 3, 2016, any sale of a principal residence must be reported (likely in a modified Form T2091, or perhaps in an upcoming amendment to the T1 return itself) in the seller’s tax return for the year of sale. This is true even if the entire gain is fully protected by the principal residence exemption. The first implementation of the new rule will require individuals who sell a home at any time during 2016 (even before October 3, 2016) to report the disposition in their 2016 tax return.

While there is no immediate financial penalty for failing to report the disposition, if the disposition is not reported the CRA will not face the normal three-year limitation period for auditing and perhaps reassessing the disposition. The reassessment period for unreported dispositions will now be extended indefinitely, regardless of whether the taxpayer’s failure to report the disposition was innocent or not.

Before this rule came into effect the CRA could only reassess beyond the normal three year limitation period where the CRA could prove carelessness, negligence, wilful default or fraud in failing to report the disposition. When a taxpayer believed a home sale to qualify as a principal residence, CRA had obvious difficulties in even finding those sales to audit them and determine whether or not the exemption had been properly claimed. The difficulty increased when the sale was reassessed after the normal three-year limitation period, with the taxpayer claiming that they had relied on the CRA’s own policy in not reporting the sale.

The obvious targets of this proposal are those who sell properties that may not qualify as a principal residence, for example (1) “quick flips” or short holding periods (the home may not qualify as capital property, a condition of being a principal residence), (2) a house that was not ordinarily inhabited in each year of ownership by the vendor (another condition to qualifying as principal residence), or (3) serial builders who build, then occupy, a house before selling (again, these would be considered inventory and not a capital property).

Failure to report a principal residence sale in one’s return for the year of sale can be cured by late-filing a form. However, the normal three-year limitation period will only start to run once the form is actually filed and, obviously, the filing itself will be an audit flag.

This seemingly small change will give CRA auditors new audit leads, and will undoubtedly give rise to many more homeowner audits and reassessments to deny the principal residence exemption as the new reporting system matures.