I am often asked whether a gain from the sale of a residential property is taxable. A residential property that is rented out to tenants for income purposes needs to be separate from the one you ordinarily inhabit for enjoyment. If you ordinarily inhabit a dwelling, that dwelling may potentially qualify as a principal residence. If it does, you may not be required to pay tax on the sale of the property.

Not all residences which you occupy as your dwelling qualify as a principal residence. This is an income tax concept and so do not get mixed up with the ordinary meaning of the term residence. To understand the concept of principal residence, the first thing you want to know is the types of property that can qualify as a principal residence: (1) a house, an apartment, a duplex, or a condominium, (2) a cottage, (3) a mobile home, (4) a trailer, and (5) a houseboat.

A leasehold interest in a housing unit or a share of the capital stock of a cooperative housing corporation—#8212;if such share is acquired for the sole purpose of obtaining the right to inhabit a housing unit owned by the corporation—#8212;may also qualify.

Along with the house, the land on which a housing unit is situated can qualify as part of the principal residence subject to certain restrictions.

A taxpayer’s principal residence for a taxation year would generally include—#8212;except where the property consists of a share of the capital stock of a cooperative housing corporation—#8212;the land upon which the housing unit stands and any portion of the adjoining land that can reasonably be regarded as contributing to the use and enjoyment of the housing unit as a residence. Canada Revenue Agency (CRA) states that the evidence is not usually required to establish that one half hectare of land or less, including the area on which the housing unit stands, contributes to the use and enjoyment of the housing unit as a residence.

The taxpayer, however, needs to be aware that any portion of the land used in earning income from business or property will not usually be considered to be contributing to occupant’s use and enjoyment.

When a taxpayer claims a portion of the expenses related to the land, such as property taxes or mortgage interest, in computing income, CRA will take the allocation of such expenses as an indication of the extent to which the taxpayer considers the land to be used to earn income.

If the housing unit is situated on a parcel of land larger than one-half hectare of land, CRA will assume the excess not to be contributing to the use and enjoyment of the housing unit as a residence pursuant the deeming provision paragraph (e) of the section 54 definition of principal residence.

As such the excess portion will not qualify as part of the principal residence. Taxpayer has the option of rebutting the CRA’s assumption by establishing the excess is necessary for such a use and enjoyment.

In establishing the use and enjoyment, you need to look at it from the land’s functional perspective. You need to establish that the excess land is clearly necessary for the housing unit to properly fulfill its function as a residence and not simply that it is desirable.

CRA may consider rebuttal on the basis that the land in excess of one-half hectare is used in connection with the particular lifestyle of the taxpayer-occupant. Examples of why there might be a rebuttal include:

• It is used for keeping pets or it is consistent with country living.

• The land in excess of one-half hectare is considered necessary for the size or character of the housing unit together with its location on the lot makes such excess land essential to its use and enjoyment as a residence.

• It is necessary to provide its occupants with access to land from public roads.

• Or, if the housing unit requires the land to be of a minimum lot size, or there is in place a severance or a subdivision restriction.

It is always a question of fact as to whether the excess land is necessary for the use and enjoyment of the housing unit as a residence. It could be that a taxpayer is required by law or regulation from municipality or province to acquire more than one-half hectare of the property.

Such a regulation or law could, for example, require a minimum lot size for a residential lot in a particular area, or has in place restriction on severance or subdivision in a particular area.

CRA may accept that the land is necessary for use and enjoyment of the housing unit if the taxpayer has to abide by law or regulation, provided the property is continuously owned by the taxpayer after the acquisition date.

This is based on the CRA’s position that in such a case the excess land is necessary for the use and enjoyment of the taxpayer.

The CRA may look into more specific details to see if the taxpayer could have made an application for a severance of the excess land, and if it was likely that such a request would have been approved.

If so, the taxpayer would generally not be considered to have acquired the excess land for the use and enjoyment.

If you happen to dispose of part of the principal residence specially in circumstances where you were required to grant an easement of part of the land on which the unit is situated, or was part of the appropriation by local authorities, the property may be designated as the taxpayer’s principal residence in order to use the principal residence exemption for the portion of the property that was disposed of. It is important to note that such a designation is made on the entire property including the housing unit that qualifies as a principal residence, and not just on the portion of the property that is being disposed of. Accordingly, with the remainder of the property subsequently disposed of, it to would be recognized as a taxpayer’s principal residence for the taxation years for which the above mentioned designation was made.

Where the housing unit is situated on land in excess of one-half hectare and part or all of the excess land is severed from the property and sold, the land sold is generally considered not to be part of the residence unless the housing unit can no longer be used as a residence due to land sale. If the housing unit can still be so used after such a sale indicates that the land sold was not necessary for the use and enjoyment of the housing unit as a residence.

If you are considering subdividing the land on which the housing unit is situated because the excess land is now severable by the relaxation of a local authority, and if you decide to sever the land or subdivide the land from the portion attached to the housing unit you may not attract any tax on the part that is subdivided, but from the time of the subdivision, or the from the time the severed parcel becomes a unit, property on its own may attract tax when you dispose of that severed land in the future. There is also a possibility that the severed parcel of land may attract a higher rate of tax in future because CRA may take the position that the land is no longer held for investment purposes or as a principal residence, and hence it is held as inventory for the taxpayer.

—The author assumes no responsibility whatsoever for any information given above because the purpose of this column is not intended to provide professional advice including, without limitations, investment, financial, legal, accounting or tax advice. For specific advice to your situation please consult your professional advisor specializing in the area of your needs. Esmail Bharwani, MBA, MSc. (Entrepreneurial Studies), FCCA, FCGA, is a Barrister & Solicitor and associate with the firm of Miller Thomson LLP. He can be reached at 298-2418 or 288-3234, or e-mail ebharwani@millerthomson.ca. Esmail’s column appears weekly in the Calgary Real Estate News.