If you sell your home for a gain, it is normally considered a capital gain. However, the principal residence exemption allows homeowners to sell their residences at a gain with no or little tax.
WARNING: the principal-residence exemption does not apply if you bought or built the home with the intention (including “secondary intention”) of selling it. Even if you move in and live there, if you sell the home soon afterwards (and certainly if you live there less than a year, or if you do this repeatedly with different homes in succession), the CRA will usually take the position that your gain is business profit, not capital gain. As a result, the CRA will deny you the principal-residence exemption and will assess you on the basis that all of the gain, not just half, is included in your income!
The principal-residence exemption, when it applies, works as follows:
First, you compute your gain from the sale of the residence. This will be the amount by which your proceeds on the sale exceed your cost of the property and your selling costs (e.g. commissions).
Then, you determine how much of that gain is exempt. The exemption formula is:
The fraction in the brackets cannot exceed 1 for the purpose of the exemption. (That is, you can’t have an exempt amount more than the gain itself.)
Thus, if the property was your principal residence for all years of ownership, or all years but one, the entire gain will be exempt, and you will pay no tax.
In other cases, you may have to report a taxable capital gain.
Example
You own a property which was your principal residence for 5 years. You owned the property for 10 years. You sell the property at a gain of $100,000.
Under the principal residence exemption, 6/10ths of the gain will be exempt. The other 4/10ths, or $40,000, is a capital gain, but since only half of capital gains are included in income as taxable capital gains, you will only include $20,000 in income.
So when is a home a principal residence for a year? Usually, it means you or your spouse or child “ordinarily inhabit” the home during the year. The CRA is very lenient in this regard, so living in the home for even a few weeks in the year can suffice. The home can thus include a cottage or other vacation property, and can be situated anywhere in the world.
However, you can designate only one property per year per family unit − you and your spouse and unmarried minor children − as your principal residence for that year. (The family unit rule applies for years of ownership after 1981. For prior years, each person in your family could designate one property.) Therefore, if you own more than one residence, when you sell one of them you will have to designate the years for which that property is to be considered your principal residence.
A special deeming rule applies where you have a residence that you inhabit, but subsequently move out and rent it to a third party. In these cases, if you make an election, you designate the property as your principal residence for up to four years while you rent it out, even though you are not living in the property in those years.
Example
You buy a condo and rent it out for six calendar years. You then move in and live there for five years, and then sell it at a gain.
You can designate the condo as your principal residence for the five years that you lived there, plus four of the years you rented it out, for a total of nine years. Because of the above formula (including the +1 factor), most of your gain (10 / 11ths of the gain) will be exempt and not subject to tax.
The catch: You are still subject to the rule under which you can designate only one property per year as your principal residence. So if you owned and lived in another home for the first six years, you could designate only one of the home or condo for each year.
The other catch: The election only works if you do not claim capital cost allowance (tax depreciation) on the condo while you rent it out.