Principal Residence 101
The Sale of a Residential Property
When a residential property is sold, there may be a capital gain equal to the proceeds of the sale less the adjusted cost base (ACB) of the property (i.e., the purchase price) less any outlays (i.e., brokerage fees relating to the sale):
Capital gains = Proceeds - ACB - Outlays
For an individual, 50% of the capital gain, up to $250,000, is added to your income for the taxation year when the property was sold. For capital gains in excess of $250,000, two-thirds of the capital gain is added to your income.
Thus, when you sell a residential property for a large gain, you may incur a significant tax liability. You can apply the principal residence exemption to eliminate or reduce the amount of the tax liability.
Note that since a residential property is considered a “personal-use property,” if the above calculation is negative, the capital loss is deemed to be nil.
The Principal Residence Exemption
The principal residence exemption allows a Canadian taxpayer to reduce or eliminate the capital gain that is included in their income relating to the sale of a property, which would reduce the corresponding tax liability.
The reduction in the capital gain is calculated with the following formula:
Capital gain reduction=((1+# of years designated as principal residence)×capital gain)/(# of years the property is owned)
The “1 +” accounts for the situation where a taxpayer sells a residence and acquires another one in the same year.
From the 2016 taxation year onwards, the CRA will only allow the principal residence exemption if it is reported on your T1 Personal Tax Return.
There are basic conditions to be met before you can designate a property as a principal residence:
The property must be a housing unit, a leasehold interest in a housing unit, or a share of the capital stock of a cooperative housing corporation you acquire only to get the right to inhabit a housing unit owned by that corporation.
You own the property alone or jointly with another person.
You, your current or former spouse or common-law partner, or any of your children, lived in it at some time during the year.
You designate the property as your principal residence by filing Form T2091.
If your property is situated on a large parcel of land, the amount of land eligible for the principal residence exemption is limited to ½ hectare (approximately 1.25 acres). Any additional land would usually be subject to capital gains treatment. An exception to increase the eligible portion of land to an area greater than ½ hectare is possible depending on various different factors – zoning bylaws, easements requirements, road access and so on. Contact us if your house is located on a large parcel of land and unsure about how the principal residence exemption works for you.
Optimizing the Principal Residence Exemption
If more than one property is owned concurrently for any period after 1981, and each of the properties qualifies as a principal residence, the property with the greatest average annual increase in value should be designated as the family’s principal residence for the maximum number of years during the ownership period. This will result in the principal residence exemption eliminating the most capital gains, reducing the overall tax liability.
From 1972-1981, more than one property can be designated as a principal residence, by having common-law partners each designate different properties as their principal residences.
In 2015, the rules regarding the principal residence exemption have been changed so that the “1 +” in the above formula may not apply to certain newcomers to Canada. Contact us for more information of how this works and discuss the ideal number of years that a property should be designated as the principal residence.
Selling a Residential Property Used to Generate Income
If a property is used to generate income (i.e., rental or business), only a fraction of the capital gain arising from the sale can be exempt under the principal residence exemption.
The CRA will consider an entire property as a principal residence if the following conditions are met:
The primary use of the property is a residence, where the income-producing purpose is a secondary use (i.e., having a day care at home, or a home office).
There is no structural change to the property.
No capital cost allowance (CCA) is claimed on the property.
Property Flipping
Starting January 1, 2023, any gain from the disposition of a residential property that was held for less than 365 consecutive days is deemed to be business income, subject to certain exceptions. Since no capital gain arises, the principal residence exemption is not applicable.
A capital gain can still be realized on a flipped property if the disposition can reasonably be considered to occur due to, or in anticipation of one of the following life events:
The death of the taxpayer or a person related to the taxpayer.
A related person joining the taxpayer’s household or the taxpayer joining a related person’s household (e.g., birth of a child, adoption, care of an elderly parent).
The breakdown of a marriage or common-law partnership of the taxpayer, where the taxpayer has been living separate and apart from their spouse or common-law partner for at least 90 days prior to the disposition.
A threat to the personal safety of the taxpayer or a related person (e.g., the threat of domestic violence).
The taxpayer or a related person is suffering from a serious disability or illness.
An involuntary termination of the employment of the taxpayer or the taxpayer’s spouse or common-law partner.
An eligible relocation of the taxpayer or the taxpayer’s spouse or common-law partner (e.g., generally, a relocation that enables the taxpayer to carry on business, be employed or attend full-time post-secondary education).
The insolvency of the taxpayer (e.g., due to an accumulation of debts).
The destruction or expropriation of the property (e.g., where the property is destroyed due to a natural or man-made disaster).
Note that a loss arising from the sale of a flipped property is deemed to be nil.
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