Dennis Hammer is a writer and finance nerd with six years of investing experience. He writes about personal finance for Wealthsimple. Dennis also manages his own investment portfolio and has funded several businesses in the past. Dennis holds a Bachelor's degree from the University of Connecticut.
When you sell your home, there’s a good chance you’ll get more than you paid for it. The value of real estate tends to rise, even when you consider events like the market crash of 2008. This is one of the major benefits of owning a home.
If your house is worth more when you sell it, the government requires you to pay taxes on that increase in value. Your principal residence, however, is a special exception.SimpleTax is simple, even if your tax situation isn’t. File your return with confidence it’s done right, and pay what you want—there’s no catch.
What is the principal residence exemption?
Whenever your property appreciates in value, you realize a capital gain. This applies to real estate, businesses, and your investment portfolio. Capital gains are subject to taxes called (unsurprisingly) capital gains taxes. Investors like capital gains taxes because they’re smaller than standard income taxes. With capital gains, you only pay tax on half the profit you earned.
Profit from the sale of a property is a capital gain that normally requires you to pay a tax. However, the principal residence exemption makes you exempt from paying capital gains tax when you sell their designated principal residence. If, like most people, you only own and live in one house, that’s your principal residence and you won’t have to pay taxes on your gains.
Your principal residence
Your principal residence has to be something you can actually live in, not a shed, storage container, or vehicle. It could be a cottage, house, condominium, apartment in a duplex or building, or a trailer, mobile home, or houseboat. It qualifies as a principal resident if it meets all of these criteria:
You own the property (alone or with another person).
It is a housing unit, a leasehold interest in a housing unit, or a share of the capital stock of a co-operative housing corporation you acquire only to get the right to inhabit a housing unit owned by that corporation.
You, your current or former spouse, or any of your children lived in it during the year.
You designate the property as your principal residence.
The property you designate as your principal residence doesn’t have to be the place where you live all the time. It just has to be the place where you, your spouse or common-law partner, or your children lived at some point during the year. Nor does the principal residence have to be in Canada. For example, if you purchased a vacation home in the United States, you can designate it as your principal residence any year you resided there for some time.
A seasonal residence—like a cabin, lake house, or ski chalet—can be considered a principal residence even if you only inhabit it for a small portion of the year, provided that you own it to inhabit, not to produce income.
This exemption only applies to the years you reside at the residence. If you rent your home to a friend while you travel to Europe for a year, you wouldn’t receive the exemption that year for that residence. But you could receive the exemption if you purchased a property in Europe and designated it as your principal residence.
Furthermore, the land where your home is located can be part of your principal residence, but rarely all of it. The amount you can consider part of your principal residence is limited to ½ hectare (1.24 acres) unless you can show that you need more land to use and enjoy your home. For example, if your town requires lots to be at least a two acres, you could designate all of it as your principal residence because you had no choice but to buy that much.
Restrictions of the principal residence exemption
As you can imagine, avoiding tax on the increased value of your home is a big boost to your retirement, but you’ll have to jump through some hoops to stay compliant with the CRA.
Qualifying for the principal residence exemption
In order to qualify for the principal residence exemption, it must meet the criteria we outlined above. You are required to report basic information about the residence on your income tax and benefit return. You will need to provide the date of acquisition, date and proceeds of the sale, and a description of the property. You have to do this for every property sold in Canada, even if the property’s gain is protected by the principal residence exemption.
Multiple principal residences
In the past, each spouse could designate a separate property for their principal residence as long as the property wasn’t jointly owned, but this isn’t the case anymore. Now, couples and their unmarried minor children can only designate one residence as their principal private residence each year.
For example, let’s say a couple owns two homes: an apartment in the city and a lake house in the country. They can only designate one as a principal residence each year. The owner will be subject to capital gains tax. However, they can choose which residence to designate (as long as they spent some time at both during the year). There might be tax advantages to designating the apartment one year and the lake house another year, depending on how the values of the properties changed.
Selling your principal residence
When you sell your principal residence, you have to report the sale on Schedule 3, Capital Gains (or Losses) with your Income Tax and Benefit Return. If the property was your principal residence for every year you owned it, you’ll designate it as the principal residence on that same form. Your online tax filing software can also help you with this.
If the residence was your principal residence some years and not others, you will need it to complete Form T2091(IND), Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust). This form lets you stipulate which years the property was your principal residence. You’ll also need to complete Form T2091(IND) if you sold more than one property in the same year and each property was—at some point—your principal residence.
You have to report changes in use of your property, as well. The CRA considers a change in use as a sale, even if you didn’t actually sell the property. For instance, if you change all or part of your principal residence into a rental or business operation, you are considered to have sold the property at its fair market value and immediately reacquired it at the same price. You have to report the resulting capital gain or loss for any years it wasn’t your principal residence.
There is no immediate financial penalty for failing to report the sale of your home. If the CRA audits you and finds the sale, however, you’ll have to pay the taxes owed, interest on those taxes, and possibly penalties. The CRA will accept a late designation in some cases, but you’ll pay a penalty of either $8,000 or $100/month for each month the original due date, whichever is lower.
Keep in mind that the three-year limits for when the CRA can audit you doesn’t apply for anyone claiming the sale of a principal residence. If you claim the exemption, you can be audited at any time for any tax year.
Calculating the principal residence exemption
The CRA calculates your capital gains from the time you bought the home, minus any years where the home was your principal residence. The formula to calculate the exemption looks like this: (# of years of principal residence + 1)(capital gain) / # of years owned
Let’s use an example: Phil has owned his home for 18 years. It was his principal residence for 15 of those years. His house is worth $50,000 more today than when he bought it (this is his capital gain). Phil’s exemption: (15+1)($50,000) / 18 = $44,444
Phil is exempt from paying $44,444 in capital gains, which means he only reports owes $5,556 in capital gains. As a Canadian taxpayer, he’s only taxed on 50% of his capital gains, or $2,778. Then we apply his marginal tax rate. If he’s in the lowest tax bracket, he’ll only pay 15% of his taxable capital gains, or $416.70 in taxes on the sale of his home. Obviously that is a significant tax savings.
What happens if your exemption amount is negative? That’s technically a loss. Your primary residence is considered personal-use property because it’s primarily used for the personal use or enjoyment of you and your family. Unfortunately, this means you can’t deduct the loss from your income.
Don’t neglect the principal residence exemption
If you own a home of any kind, it’s critical that you claim the principal residence exemption on your tax return. Failing to claim this exemption will cost you thousands of dollars—perhaps tens of thousands. Your online tax software should walk you through it, but if you prefer to file by paper, make sure to include Schedule 3.