What Are the Tax Implications of Selling a House Below Market Value in Canada?

Tax Rules for Below-Market Home Sales

Selling a house is a significant financial event. Many sellers want the highest possible price. Sometimes, a seller chooses to sell their home for less than its full value. This often happens in transactions between family members. For example, parents may sell a home to their child at a discount to help them enter the housing market. While this act is generous, it creates specific tax situations you must understand. The Canada Revenue Agency (CRA) has clear rules for these types of sales.

These rules exist to ensure fairness in the tax system. The government wants to prevent people from avoiding taxes by artificially lowering sale prices. When you sell a property to someone you know for less than it is worth, the CRA may not accept the sale price for tax calculation purposes. They will look at the property’s fair market value instead. This can lead to unexpected tax bills for the seller. It also has important consequences for the buyer’s future tax situation. Understanding these tax implications before you sell is essential for sound financial planning.

How the CRA Views Sales to Family and Friends

The CRA categorizes transactions into two types: arm’s length and non-arm’s length. An arm’s length transaction happens between two independent parties. Neither party has influence over the other. A typical home sale between strangers is an arm’s length transaction. A non-arm’s length transaction occurs between related individuals. This includes family members like parents, children, spouses, and siblings. It can also include corporations and their controlling shareholders.

The government pays close attention to non-arm’s length transactions. When you sell a property to a related person for less than its fair market value (FMV), the CRA applies a special rule. For the seller, the CRA deems the sale to have occurred at the property’s FMV. This means you calculate your capital gain based on the home’s actual worth, not the discounted price you received. You will pay taxes on a gain you did not fully realize in cash. This rule prevents families from transferring property wealth without paying appropriate tax.

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Related Article: Are Realtor Fees Tax Deductible for Rental Property?
Related Article: How Do I Avoid Capital Gains Tax on Rental Property in Canada?

Can the Principal Residence Exemption Help?

The Principal Residence Exemption (PRE) is a significant tax benefit for Canadian homeowners. It can eliminate or reduce the capital gains tax on the sale of your home. To qualify, the home must be your principal residence for all the years you owned it. If you meet this condition, you can use the PRE to shelter the entire capital gain from tax. In our previous example, if the house was your principal residence, the $500,000 capital gain would be tax-free.

The situation changes if the property was not your principal residence for the entire ownership period. For instance, you may have rented it out for several years. In that case, you can only claim the PRE for the years you lived in the home. You would need to calculate the capital gain for the years it was an income-producing property. This portion of the gain would be subject to tax. You must report the sale and designate the property as your principal residence on your tax return to claim the exemption, even if no tax is due.

What Happens to the Buyer in a Below-Market Sale?

The tax implications of a below-market sale also extend to the buyer. While the seller must use the fair market value to calculate their capital gain, the buyer’s situation is different. The buyer’s adjusted cost base (ACB) for the property is the actual price they paid, not the higher fair market value. This detail is very important and can create a future tax problem. This treatment can lead to what is known as double taxation.

Let’s continue our example. You sold the house with an FMV of $900,000 to your child for $700,000. Your child’s ACB for the property is $700,000. Years later, your child sells the property for $1,100,000. Their capital gain will be $400,000 ($1,100,000 minus $700,000). The $200,000 difference between the FMV ($900,000) and the discounted price ($700,000) was already taxed as a capital gain for you, the seller. Now, it is being taxed again as part of your child’s capital gain. This is an expensive outcome that many families overlook.

Gifting a Property: A Different Approach

Some people consider gifting a property instead of selling it below market value. You might think this avoids the tax issues, but the CRA has rules for gifts as well. When you gift a property to someone, the CRA treats it as if you sold the property at its fair market value. The seller, or person giving the gift, is deemed to have received the FMV. They must report any resulting capital gain and pay the necessary taxes. This is the same tax outcome the seller faces in a below-market sale.

The key difference lies with the recipient. The person who receives the gifted property acquires it with an adjusted cost base equal to the fair market value at the time of the transfer. In our example, if you gifted the $900,000 house, your child’s ACB would be $900,000. This approach avoids the double taxation problem. When your child later sells the house, their capital gain will be calculated from a higher starting point. This strategy may be more tax-efficient for the family as a whole over the long term.

Conclusion

Selling a house below market value is a complex decision with lasting financial consequences for both the seller and the buyer. The seller must pay capital gains tax based on the home’s fair market value, not the reduced price. The buyer receives a lower cost base, which can lead to a larger tax bill when they sell the property in the future. The Principal Residence Exemption can provide significant relief for the seller, but it may not cover the entire gain if the property was used for other purposes.

Before you proceed with a non-arm’s length real estate transaction, you should seek professional advice. Getting an official appraisal is the first step. This establishes the fair market value and provides clear documentation for the CRA. You should also consult with a tax advisor or accountant to understand your specific obligations. A real estate professional can guide you through the process, ensuring all documentation is correct and you understand every step. Careful planning helps your act of generosity truly benefit your loved ones without creating unintended financial burdens. [ 1 ]