Q: My boyfriend and I met as divorced individuals both owning our own homes. Planning for the future we purchased a joint tenant property (last spring, so in 2015). He moved into his new property as his principal resident and rented out his own property. I continued to live in my own property as my kids finished their high school years. I just sold my own property, closing in summer, which is my principal and exempted from cap gains. We now also want to sell the joint home purchased last spring and get another property due to accommodation changes. Will there be capital gains tax to pay for either party?
A: First a bit of background on the principal residence exemption: this is a dwelling you own and that is “ordinarily inhabited” by you or a member at some time during the year. There are no minimum number of days required. The dwelling may include a house, condo, trailer, or even a houseboat.
Since 1982, there can only be one tax-exempt principal residence per married couple. In 1993 the “one principal residence per couple” rule was extended to common-law couples. From your description, I will assume you did not live together in the new property and therefore do not qualify as a common law couple for tax purposes. Therefore, each of you will have separate tax consequences for these properties. I have further assumed that your property sale is closing in summer of 2017.
For your boyfriend, there is a reportable change of use in the old principal residence at the time he moved into your jointly owned new property. Any accrued gains would be tax exempt until this deemed disposition. After this it becomes a taxable rental property. A valuation should be secured to establish a cost base for the purpose of calculating future gains or losses.
Your boyfriend can either adjust the 2015 return to report the change of use or elect to defer reporting until the property is actually sold. At that time, the exempt gain would be calculated on form T2091 Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust).
There may be some tax advantages in deferring, depending on which property appreciated the most in the ownership period, but get help with this complicated form from a qualified tax specialist to be sure.
Turning to your property, indeed it would be tax exempt if you ordinarily inhabited it in each year of ownership and did not live with your boyfriend in either his residence or the jointly owned property as a common law spouse. But that also means that any subsequent gains in value on your half of the joint tenant property will a taxable property to you. If there is an accrued gain, it will be added to your income in 2017.
But if you had stayed with your boyfriend in the new property now and again, you would have the option to elect that joint tenant property as your principal residence. Unless there is a substantive gain, it is unlikely you will want to do this. Get the valuations and you’ll know for sure.
If your co-habitation was more than occasional, and you meet the definition of a common law couple, everything gets more complicated: only one tax exempt principal residence between the two of you is allowed.
Get professional tax help with these transactions to avoid tax audit grief down the line. Remember, reporting principal residence dispositions is a requirement starting with the 2016 tax return and there are significant penalties if you fail to complete the second page of Schedule 3, even if the gains are exempt.
Evelyn Jacks is president of Knowledge Bureau, which offers e-learning at knowledgebureau.com. Evelyn tweets @evelynjacks and blogs at evelynjacks.com
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