Principal Residence Exemption: Capital Gains on Your Home in Canada

What the principal residence exemption covers

The principal residence exemption is a reduction of the capital gain on a housing unit you designate as your principal residence. If the property was solely your principal residence for every year you owned it, the CRA says you do not have to pay tax on the gain. If it was a rental, a business property or someone else’s home for part of the time, only part of the gain is sheltered.

According to the CRA, a property qualifies as your principal residence for a year only if it meets all four of these conditions:

• It is a housing unit (a house, cottage, condominium, apartment, duplex unit, trailer, mobile home or houseboat), a leasehold interest in one, or a share in a co-operative housing corporation bought only to live in a unit it owns.
• You own it, alone or jointly with someone else.
• You, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year. CRA’s folio on principal residences says even a short stay in the year can be enough for a home to be “ordinarily inhabited”.
• You designate it as your principal residence for that year.

Land, families and the one-home rule

Land under and around the home counts too, usually up to half a hectare (1.24 acres). You can include more only if you can show it was needed to use and enjoy the home, for example when a municipality’s minimum lot size was larger than half a hectare. Extra acreage beyond what is needed is taxed like any other capital property.

Only one home per family can be designated for each year from 1982 onward. For 1993 and later years the CRA defines your family as you, your spouse or common-law partner (unless you were separated all year under a court order or written agreement), and your unmarried children under 18. That is why a couple cannot shelter both a city house and a cottage for the same year: they must pick one property for each year.

How to calculate the exempt part of the gain (the plus-one rule)

When a home was not your principal residence for every year, the exempt part of the gain is worked out with the formula in CRA’s Income Tax Folio S1-F3-C2: gain × (1 + years designated) ÷ years owned. “Years owned” counts every tax year ending after you acquired the property in which you owned it, including the year of sale.

The extra “1” is the plus-one rule. It exists because people often sell one home and buy another in the same year, and only one property can be designated per year. The CRA confirms the extra year is only available if you were resident in Canada in the year you bought the property; a non-resident in the purchase year gets no extra year.

Worked example: a family in Ontario owns a city house and bought a cottage in 2016 for $300,000. They sell the cottage in 2026 for $620,000 after selling costs, a gain of $320,000 over 11 tax years of ownership. If they designate the cottage for 5 of those years, the exempt part is $320,000 × (1 + 5) ÷ 11 = $174,545, leaving $145,455 taxable as a capital gain. With $120,000 of other income, our engine puts the extra 2026 federal and Ontario tax at about $32,554, against about $76,500 with no designation at all. The cost is that the city house cannot be designated for those 5 years, so part of its gain becomes taxable when it is eventually sold.

Choosing between a house and a cottage

The usual approach is to compare the gain per year of ownership on each property and designate the years to the property with the larger annual gain, while keeping the plus-one year in mind. Because the decision is only made when you sell (or are deemed to sell), you can wait until you know the actual figures for the first property sold.

Keep written notes of which years you used. The CRA tells people who use the plus-one rule to keep their decision in writing for when the second property is sold, because years already designated to the cottage cannot be reused for the house.

Reporting the sale: Schedule 3 and Form T2091(IND)

Report every sale of a property that was ever your principal residence on Schedule 3 of the return for the year of sale, and tick the right box at line 17900. Box 1 is for a property that was your principal residence for every year you owned it, or every year except one; box 3 is for a property that was your principal residence for some but not all of those years, which also requires the rest of Form T2091(IND) to calculate the taxable part. The CRA says to complete only page 1 of the T2091(IND) when the home was your principal residence for all years, or all years except one.

If you sold more than one former principal residence in the same calendar year, you need a separate T2091(IND) for each property. When a home is partly rented, split the price and the adjusted cost base between the personal and income-earning parts (by floor area or number of rooms, if reasonable) and report only the income part on line 13800. A loss on your home is never deductible, because a home is personal-use property.

If you forgot to designate: late designation penalty

If you forgot to report the sale or the designation, ask the CRA to amend the return for the year of sale as soon as possible. The CRA can accept a late designation in certain circumstances, but a penalty may apply.

Under section 220(3.5) of the Income Tax Act, the penalty for a late election is the lesser of $8,000 and $100 for each complete month from the original due date to the day the request is made. Someone who notices 18 months after the filing deadline faces up to $1,800, and the cap is reached after 80 months. That is still usually far less than the tax on an undesignated gain.

Changes in use, rentals and the flipping rule

Turning your home into a rental normally counts as selling it at fair market value. Under subsection 45(2) you can elect, by attaching a signed letter to the return for the year of the change, to be treated as not having changed its use. While the election is in effect you can keep designating the property for up to four years, or longer if you moved because of a job relocation and meet the 40 km test, but you cannot claim capital cost allowance on it.

Going the other way, subsection 45(3) lets you postpone the gain when a rental becomes your home, and designate it for up to four years before you move in, provided no capital cost allowance was claimed after 1984.

Since January 1, 2023 the residential property flipping rule treats the gain on a home owned for less than 365 consecutive days as business income, with no principal residence exemption, unless the sale was due to a listed life event such as a death, a new child, separation, serious illness, a job loss or a work relocation that brings you at least 40 km closer.