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 than its adjusted cost base when you sell it, the government requires you to pay taxes on that increase in value. Your principal residence, however, is a special exception.
Wealthsimple Tax is a simple way to file your taxes. File your return with confidence it’s done right, and pay what you want—there’s no catch.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. Tax law on capital gains says that only half the profit you earned is considered taxable income.
Profit from the sale of a property is normally a taxable capital gain. However, the principal residence exemption makes you exempt from paying capital gains tax on the sale of a residence that is the principal residence for your family unit—that is, a home that has a principal residence designation. If, like most people, you only own and live in one house, that’s your principal residence and you won’t have to include the income you generate from the sale of this property as capital gains income. According to the Income Tax Act, you can designate only one property as your principal residence in any given year.
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, 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 by running it as a rental property.
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 won’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 0.5 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 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’s rules.
Qualifying for the principal residence exemption
In order to qualify for the principal residence exemption, the residence 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 principal residence 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 for the family unit 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 spend 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. You will need 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. Your online tax filing software can also help you with this.
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 operation to generate business income, 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 after the original due date, whichever is lower.
Keep in mind that the three-year limit 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 principal residence exemption formula 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 including $44,444 of the capital gain as income, which means only $5,556 will be included as income. 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.
Why you shouldn’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 when you sell your principal residence or have a change in use of the property. 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 and T2091(IND).
Frequently Asked Questions
The Income Tax Act defines a principal residence as a home you live in, such as a house, cottage, condo, trailer, or other residence, and not a shed, garage, or storage container. It must meet all of the following criteria to meet the definition of principal residence for tax purposes:
You own the property, either by yourself or jointly with someone else.
The property must be 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 officially designate the home as your principal residence to tax authorities.
As a Canadian homeowner, you must report basic information about the sale of your principal residence on your T1 Income Tax and Benefit Return to claim the full principal residence exemption. The needed information includes the date of sale, the proceeds of disposition, and a description of the property.
Report the sale of your home in the year it occurred by completing Schedule 3 and filing it with your T1 Return. Also complete Form T2091 to designate a home as your principal residence for the year of the sale and to determine the exemption amount.
The principal residence exemption allows Canadian homeowners to avoid paying capital gains taxes on the sale of their primary residence. The guidelines state that you must own the property, that it must be intended as a housing unit, that you and your family lived in it during the year you’re claiming it, and that you have officially designated it as your principal residence.
The guidelines also state that you don’t have to live in a property for the entire year to designate it as your primary residence for that year, and you can even designate a seasonal property like a ski chalet as long as you maintain the home as a place to live instead of as a place to produce business income.
Liberals’ agenda includes introducing an anti-flipping tax on residential properties to reduce speculation and bring down rapid price acceleration in the housing marketplace. Accordingly, in December 2021, the House of Commons began reviewing draft legislation for a new Underused Housing Tax Act. The act would impose an annual tax of 1% on the value of residential property located in Canada that is owned by persons who are neither citizens nor permanent residents of Canada with the exception of certain exemptions. Residential property that is the primary place of residence for that calendar year for the owner and/or their family are exempt from this new tax.
A married couple can designate only one residence as their principal residence. If they sold that property in a given year, they both must report the gains from the sale on their tax returns. They must each report a percentage of the gains based on their investment in the property. In many cases, each spouse will own 50% of the property, so each spouse would report 50% of the gains of the sale on their return. If one spouse owns a larger percentage of the home, however, that person must report the corresponding percentage of the capital gains on their return.
The principal residence exemption formula is intended to calculate your capital gains from the sale of your home for the years you use it as a principal residence. The formula takes the number of years you used it as a principal residence (plus one), multiplies that by the capital gain, and then divides that total by the number of total years you’ve owned the property. Here is the formula: (# of years of principal residence + 1)(capital gain) / # of years owned. The formula excludes the years you did not designate the property as your principal residence so that you are not able to exempt your capital gain during those years.
In any given tax year, a taxpayer can only designate a single property as their primary residence for that year, with the exception of a year in which they sell one property and buy another (called the “plus 1” rule). This restriction also applies to the family unit: the taxpayer, their spouse or common-law partner, and minor children. This means that a husband cannot designate one house as the principal residence while his wife designates another. This is true even if in reality they do not live together but instead each spend all their time in different homes. For tax purposes, they can only choose one of those residences to designate as primary and for which to capture the principal residence exemption.
You are allowed to designate a different home as your family unit’s primary residence each tax year, however. So if a husband and wife live in different homes, they could alternate which home they designate as the principal residence year after year, thereby capturing half of the potential exemption for each property over time.
When a homeowner dies, their estate, including their home, must be “disposed of”—that is, gifted or willed to the appropriate people in accordance with law. Such transfers are subject to a deemed disposition tax, which equates to the capital gains tax on a sale. This tax is reported on the donor’s income tax return and treated as a “sale” under Canadian income tax rules. If the property was the principal residence of the donor, the “sale”—in reality, the inheritance—of the property is exempt from capital gains taxes under the principal residence exemption.
The CRA does not define a particular amount of time that a homeowner and/or their family must live in a house to have it qualify as a principal residence and receive the capital gains exemption. The wording in the tax regulations specifies that the home should be “ordinarily inhabited” within the calendar year, which suggests the threshold for qualifying is not very high, thought it is generally recommended by experts that you follow the spirit of the law by only designating the home that did serve as your primary residence in a given year, whether that residence was a house, a cottage, a condo, a houseboat, or something else.
The way to get the full benefit from the principal residence exemption as a Canadian homeowner is to designate the same home as your principal residence for all the years that you own it. This is because the CRA’s formula for figuring out your exemption excludes the years the home was not designated as your principal residence. Here is the formula: (# of years of principal residence + 1)(capital gain) / # of years owned. The higher the numerator—that is, the number of years you’ve used the property as your principal residence—the lower the denominator (the number of years you’ve owned the home), and accordingly the higher the results of the formula and the greater your exemption.
Last Updated April 15, 2022
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