Principal Residence Exemption in Canada

For many Canadians, their home will eventually become one of their largest personal assets. Fortunately, Canada’s principal residence exemption can allow some or all of the gain on the sale of a home to be received tax free.

However, the exemption is not automatic, and the rules can become complicated once you or your spouse own multiple properties or sell a property shortly after purchasing it.

Here are some of the key rules to be aware of.

1. What is the principal residence exemption in Canada?

The principal residence exemption is a tax rule that can allow you to sell your home without paying tax on some or all of the capital gain.

For example, if you purchase a home for $1 million and later sell it for $1.5 million, you would generally have a $500,000 capital gain before considering selling costs and other adjustments.

If the property qualifies as your principal residence throughout the period you owned it, the principal residence exemption can generally shelter the entire gain from tax.

However, simply living in a property does not automatically mean that the entire gain will be tax free. There are specific rules governing:

• what properties can qualify as a principal residence;

• which years you can designate a property as your principal residence;

• what happens when you own more than one qualifying property; and

• how much of the gain is ultimately exempt.

2. What qualifies as a principal residence?

A principal residence does not necessarily have to be a traditional detached home. A house, condominium, cottage and certain other types of housing are all properties that can qualify as a principal residence.

In order for such property to qualify as a principal residence, two conditions must be met:

1. You must have ownership of the property (either solely or together with another person); and

2. you, your spouse or common-law partner, former spouse or common-law partner, or child must ‘ordinarily inhabit’ the property during the year.

There is no requirement that you live in the property for the entire year. Typically, living in a property for even a relatively short period can be sufficient for it to be considered ordinarily inhabited.

This means that a cottage or vacation property can potentially qualify as a principal residence as well.

3. Only one property per family per year

One important limitation is that only one property can generally be designated as the principal residence of a family unit for a particular year.

For these purposes, a family unit generally includes you, your spouse or common-law partner and your children under age 18.

This becomes important if you own more than one property.

For example, suppose you own a home in Toronto and your spouse owns a cottage which both of you visit a few times a year.

Both properties may qualify as principal residences, but you generally cannot designate both properties as principal residences for the same year.

When one of the properties is eventually sold, it may therefore be worthwhile to compare the appreciation on each property before deciding which years should be designated to each property.

The Principal Residence Exemption Formula:

The principal residence exemption contains what is commonly referred to as the “plus one” rule. The additional year is intended, in part, to accommodate situations where you sell one principal residence and acquire another during the same year.

The availability of the “plus one” rule is subject to certain residency requirements.

Example: choosing between a home and a cottage

Suppose Dr. Smith and her spouse own the following two properties:

1) Toronto Home (owned by Dr. Smith)

• Years owned: 2017 - 2026 (10 Years)

• Capital Gain: $300,000

• Capital Gain per year owned: $30,000

2) Muskoka Cottage (owned by her spouse)

• Years owned: 2022 - 2026 (5 Years)

• Capital Gain: $300,000

• Capital Gain per year owned: $60,000

The couple sold both homes in 2026.

Remember a family unit (i.e. married couple and their children under the age of 18) can only designate one property as their principal residence in any given year.

A simple way to think about the decision is that each year designated to the Toronto home shelters approximately $30,000 of gain, while each year designated to the cottage shelters approximately $60,000 of gain.

As a general rule of thumb, where two properties qualify for the same years, it is often better to designate the principal residence exemption to the property with the higher gain per year of ownership.

Going back to the example, it would be a good idea to designate Muskoka Cottage as their principal residence for four years (say, 2023 - 2026). If so, the entire gain of $300,000 would be exempt from tax as follows.

Then, on the Toronto Home, the principal residence exemption would shield $210,000 of the $300,000 capital gain from tax.

The remaining $90,000 gain on the sale of the Toronto Home would not be sheltered by the principal residence exemption.

4. Selling a property shortly after buying it

Another important rule applies if a residential property is sold after being owned for less than 365 consecutive days.

Unless one of the specific life event exceptions applies, the property will generally be considered a flipped property.

The resulting profit is treated as fully taxable business income rather than a capital gain, and the principal residence exemption is not available. There are exceptions for certain events such as a death, relationship breakdown, serious illness, employment relocation and other qualifying circumstances.

5. You still have to report the sale

A common misconception is that nothing needs to be reported because the gain on a principal residence is tax free.

For dispositions occurring in 2016 and later years, the sale must be reported on your income tax return in order to claim the principal residence exemption.

Individuals will generally report the disposition on Schedule 3 and complete Form T2091(IND) to make the principal residence designation.

If the sale was not properly reported, the CRA can accept a late designation in certain circumstances, but penalties may apply.

6. Final Thoughts

For many homeowners, the principal residence exemption means that the gain on the sale of their home will ultimately be tax free.

However, the rules become more important when you own more than one property, such as a home and a cottage. In those situations, deciding which property to designate as your principal residence can have a significant impact on the amount of tax ultimately payable.

If you own multiple properties, it can also be helpful to review the potential principal residence designation before a property is sold, rather than simply assuming that your primary home should receive the exemption for every year.

Warm regards, 

Francis Do, CPA, CA

Have any questions? Please contact Francis Do at Francis@francisdo.com or 416-572-9633.

Disclaimer: This article is not intended to be a tax advice. Always consult and verify with a tax professional.