For many dentists, the two largest financial assets are your home and dental practice. While you may want to hold on to these assets for your entire life, there may come a time when you choose to sell them or be forced to sell them in the eyes of the tax department due to death. With the appreciation in values of both home properties and dental practices, a sale of this magnitude could trigger an enormous tax bill. Fortunately, the government provides tax tools which allow you to minimize taxes on the sale and potentially pay no taxes at all. These tools would be the Principal Residence Exemption (PRE) and the Lifetime Capital Gains Exemption (CGE).
PRINCIPAL RESIDENCE EXEMPTION
Your home is one of the few entirely tax-exempt personal assets you will ever have. Any gains on the sale of your home are tax-exempt provided you meet the following criteria:
1. The property must qualify as a principal residence. In general, the property could be a house, condo, cottage, mobile home, trailer or a house boat.
2. You and/or your spouse or common law spouse (if you are married or living common law) must own the property.
3. The property must be “ordinarily inhabited” by you, your spouse/common law spouse or child during the year. In general, this means you lived in the property for at least a short period of time each year. The PRE does not apply to investment or rental properties.
Other rules to be aware of when claiming the PRE are as follows:
1. You and your spouse can only designate one property as a principal residence each year. If you own two homes (i.e., one house and one cottage), only one of the properties will qualify for the PRE (except if owned prior to 1982).
2. In the year of sale, the PRE rules allow you to effectively claim two properties as your principal residence for that year, saving you some taxes on the sale of your second property.
3. If you own more than one principal residence, you can pick and choose which years each property is designated as the principal residence. Depending on the year-to-year appreciation of the two properties, this could result in significant tax savings.
4. You only have to designate a property as a principal residence in the year of sale. Therefore, you can defer this decision and discuss it with your accountant when it comes time to sell.
5. You can multiply the PRE by helping your children over 18 purchase their first home or condo. When the child is ready to sell their home, the gains are tax-free.
With a single family home, claiming the PRE is simple. In most cases, you don’t have to report the sale of the home on your tax return. In the case of multiple homes, special election forms will have to be filed to designate the property as a principal residence and for which years this was done.
CAPITAL GAINS EXEMPTION
There is also an exemption on the sale of your dental practice. The first $813,600 (based on 2015, indexed to inflation each year) of capital gains on the sale of qualifying shares is exempt from regular income tax due to the CGE. This exemption requires significant planning to ensure you qualify. Here are the primary criteria to claiming the CGE:
1. The CGE applies only to small business shares. If you don’t have a Professional Corporation (PC) or hygiene/technical services corporation (HSC/TSC), you likely can’t claim the CGE.
2. Your PC/HSC/TSC must meet the following tests:
a. You and/or someone related to you must have owned the shares for a period of at least 24 months prior to the sale.
b. You cannot have more than 50 per cent of the value of your company’s assets in the form of excess cash and investments including stocks, GICs and non-dental real estate during the past 24 months prior to sale.
c. You cannot have more than 10 per cent of the value of your company’s assets in the form of excess cash and investments at the time of sale.
3. You and other equity shareholders of the PC/HSC/TSC must have CGE available. Consider the following:
a. If you have claimed the CGE on a previous sale, you would only be able to claim a tax break on the remaining CGE available.
b. If you have reported large losses in the past on tax shelters or bad investments, this could significantly reduce the amount of CGE you have available.
Keep the following tips in mind if you are in a situation where you do not qualify for the CGE:
1. Pay dividends to yourself or family members to eliminate excess cash/investments from your PC and/or HSC/TSC. Ideally, this should be done over a long period of time and on a regular basis to minimize annual taxes.
2. Pay dividends to yourself if you have reported large investments losses in the past. The dividends will help clear out your past investment losses and may help you re-qualify for the CGE.
3. If you have claimed CGE in the past and do not have any CGE available, consider whether your family members have any CGE available. Multiply your CGE by making other family members equity shareholders of your PC or HSC. Each CGE is worth up to about $201,000 in tax savings.
4. If you currently don’t have a PC, the tax laws may allow you to set up a PC and sell the share without having to own the shares for at least 24 months.
5. Planning for the sale of your PC shares should start well in advance (i.e. at least three years) of the sale. This will help you reduce mental stress and minimize taxes.
Tax relief is rare. Being able to shelter two of your most important assets from taxes should not be taken for granted. With the right planning, there could be significantly more money for you and your family.
This article was prepared by David Chong Yen, CPA, CA, CFP and Louise Wong, CPA, CA, TEP of DCY Professional Corporation Chartered Accountants who are tax specialists and have been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail firstname.lastname@example.org / email@example.com. Visit our website at www.dcy.ca. This article is intended to present tax saving and planning ideas, and is not intended to replace professional advice.