Case Study: Planning the Sales of Home and Cottage

Is the gain tax exempt? Solve this case study: Phil and Sylvia have owned their home in the city for 20 years and their cottage at the lake for 10 years in that 20-year period...

The cottage was sold for a substantial sum last year—$500,000—despite the fact that they only paid $150,000 for it. They did not report it for tax purposes, because they designated it as their tax-exempt residence for the entire ownership period.

This year they are thinking of selling their home, which cost them $225,000. They think they can get a price of $650,000. Will any part of the gain be tax exempt?

Answer

The answer is yes. That’s because there was a period of time before they owned the cottage in which the exemption would qualify. Phil and Sylvia would have to complete Form T2091 to take this into account.

The calculations would look like this:

1. The capital gain on the city home is $425,000 (= $650,000 less $225,000).
2. Tax-exempt portion: Designate the city home as principal residence for 10 years, as only 10 years of the ownership period included the cottage.

To calculate the exempt portion¹, the number of years the house is designated as the principal residence plus 1 (10 + 1 = 11) is divided by the total number of years the house was owned (20 years).

The exempt portion of the gain: (11/20 x 425,000) = $233,750.

The taxable portion of the gain: $425,000 – 233,750 = $191,250, and 50% of this is taxable on Schedule 3 ($95,625).

¹ Calculation Notes:

1. Calculate the gain. The capital gain on the property is first calculated, using regular rules for capital gains and losses.
    
2. Calculate the exempt part of the gain. Once this has been done, the exempt portion is then subtracted from the capital gain. The exempt portion of the gain is calculated as follows:

Total gain x  (Number of years designated as Principal Residence + 1) Number of years the property was owned

Note the “+ 1.” Because the numerator in the exemption formula adds 1 to the number of years that a property is designated as a principal residence, it is only necessary to designate a property for one year less than the total number of years it was owned to exempt the entire gain. This is because two residences will be owned in the year that the taxpayer moves from residence to another.