If you’ve sold your home in Canada, you may have benefited from the principal residence exemption. The principal residence exemption can reduce or eliminate the capital gains you pay on the profits from the sale of your home.
Here’s everything you need to know about the principal residence exemption, what it is, how it works, and how to determine if you qualify.
What Is The Principal Residence Exemption (PRE)?
The principal residence exemption (PRE) is a tax break available to Canadian homeowners. It can reduce or eliminate the capital gain taxes you have to pay if you profit from the sale of your home.
Your principal residence is the house you consider your primary home. It’s where you and your family live at some point during the year. When you sell your primary residence, the PRE can help you to avoid paying tax on the profits.
Eligibility For The Principal Residence Exemption
To take advantage of the principal residence exemption, you need to meet all four of the government’s principal residence requirements:
- Your residence can be a ”house, cottage, condo, apartment in a building or duplex, a trailer, mobile home, or houseboat.
- You own the property alone or jointly with someone else.
- You, your spouse, or your kids live there at some time during the year.
- You designate the property as your primary residence.
What Is Considered A Primary Residence?
The property you designate as your primary residence doesn’t have to be where you live all the time. As long as you meet the ordinarily inhabited rule, you can designate the property of your choosing.
| What is the ordinarily inhabited rule? The ordinarily inhabited rule means you, your spouse, partner, or child live there at some point during the year. You can even live there for a short time and qualify, as long as the main reason for owning the house isn’t to make an income. |
The land on which your home is located is also considered part of your principal residence up to half a hectare (1.24 acres). There are circumstances where the size of land can increase if you show that you need more land to use and enjoy your home.
Learn more: What is a principal residence?
How The Principal Residence Exemption Works
You can claim a full or partial exemption depending on how long your property was your principal residence.
Full Exemption
If you meet all of the principal residence requirements, and you’ve lived in your house at some point every year since its purchase, you’ll likely qualify for a full exemption. This means you won’t have to pay tax on any of the gains from the sale.
Partial Exemption
If your home wasn’t designated as your principal residence every year you owned it, you can still take advantage of a partial residence exemption. For instance, you may have lived in your home for years and then rented it out while you travelled. The years you lived there will qualify for the exemption, the years you were away won’t qualify.
How To Calculate The Capital Gains Tax With The Principal Residence Exemption?
Let’s look at how to calculate the capital gains tax with exemption using an example. Below is the formula to calculate PRE:
| [(1 + # of years designated) ÷ # years owned ] x capital gain |
Imagine you owned a home for 15 years and it was your primary residence for 10 years. You originally purchased your home for $300,000, and sold it for $500,000 giving you $200,000 in capital gains.
Full Exemption Calculation
If this property was designated as your primary residence for the full 15 years, you wouldn’t have to pay capital gains on any of the $200,000 profit.
Partial Exemption Calculation
[(1 + 10 years designated) ÷ 15 years owned] x 200,000 (capital gain) = $146,667
This means you don’t have to pay capital gains on $146,667. You would have to pay taxes on the remaining $53,333. Capital gains are taxed at 50%.
$53,333 x .50 = $26,667.
The total taxable capital gains are $26,667 which would then be taxed at your marginal tax rate.
| Note: Do note that individuals with capital gains of more than $250,000 will be taxed at 66.67%. Meaning if you had a capital gain of $350,000, you’d need to include 50% of the first $250,000 and 66.67% of any capital gains exceeding $250,000, which would be $100,000. |
How To Report The Sale Of A Principal Residence
Starting in 2016, it became mandatory to report the sale of your principal residence. You report the sale and designate your property on Schedule 3, Capital Gains (or Losses). Then you complete page one of Form T2091 (IND), Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust).
Special Considerations For The Principal Residence Exemption
Before you claim the principal residence exemption, keep these points in mind:
Multiple Properties
You can only designate one property, per family, per year as your principal residence. If you own multiple properties, you may want to speak to a tax professional to see what you can do to reduce your taxes.
Changes in Use
This is when your property is considered sold, or partially sold, even though you didn’t sell it. It’s because you’ve changed all or part of your property from your principal residence to a rental or business. Or you’ve changed your rental or business to a principal residence. So if the property was your principal residence for years before you changed its use, you don’t have to pay taxes on any gains during those years.
The “4-Year Rule”
When you change your business or rental property to your principal residence, you can elect to postpone reporting the disposition until you actually sell it. You can only do this if you haven’t claimed CCA on the property. If you decide to make this election, you can designate the property as your primary residence for up to four years before you occupy it as your principal residence.
Learn more: How To Avoid Capital Gains Tax On Rental Property In Canada
Can You Claim The Principal Residence Exemption on Inherited Property?
If you inherit a principal residence, you can continue to designate the property as a principal residence if you meet the required conditions. Remember, you can only designate one principal residence per family, per year. If you already own a home, you’ll have to decide which property you want to designate.
If you don’t designate the inherited property as your primary residence, when you go to sell it the exemption may apply only to the period the deceased owned the home. Any capital gains accrued after the transfer could be taxable.
Situations Where the Exemption May Not Apply
There are a few situations where these conditions may not be met and where the exemption may no longer apply.
- Non-Primary Residences: If the property is not ordinarily inhabited by you, your spouse, partner, or child, it is not considered your primary residence. Examples might include a vacation home or a secondary home.
- Rental Properties or Investment Properties: In most cases, a rental property or investment property that is no longer your primary residence does not qualify for the PRE. There are some exemptions. For instance, if you rent a unit to your child, you could designate the home as your principal residence.
- Flipped Properties: As of 2023 the CRA considers profits made from the sale of a house that is held for less than 12 months to be considered business income and doesn’t qualify for the PRE.
What Happens If You Forget to Report the Sale of Your Principal Residence?
If you sell your house and forget to designate it as your principal residence, you’ll have to ask the CRA to amend your tax return. In some circumstances, the CRA will accept a late designation but, you might get stuck paying an $8,000 penalty, or $100 for each month your request was late, whichever is less.
Bottom Line
Many Canadians save thousands of dollars on capital gains taxes with the principal residence exemption. If you own one home and live in it each year until you sell, you can benefit from a full exemption. If you own multiple homes, you can still use the PRE but consider speaking to a tax professional for strategies to reduce your taxes.
