Principal Residence Exemption: Complete Guide

What Qualifies as a Principal Residence?

A housing unit (house, condo, cottage, etc.) that you:

• Owned (alone or jointly)
• Ordinarily inhabited at some point during the year
• Or that your spouse, former spouse, or child ordinarily inhabited

Types of Properties That Can Qualify

• House, condominium, apartment
• Cottage or vacation property
• Mobile home or trailer
• Houseboat
• Share in a co-operative housing corporation

The One-Per-Family Rule

Critical rule: Only ONE principal residence per family unit per year.

Family Unit Includes

• You
• Your spouse or common-law partner
• Your unmarried children under 18

This Means

• If spouse owns cottage and you own city home, only one can be PRE each year
• Must choose which property to designate for each year of ownership
• Planning required when selling either property

The PRE Formula

The exemption is calculated using the "plus one" formula:

Why "Plus One"?

• The extra year accounts for the fact you can't designate a property for the year of acquisition AND year of sale if buying a new home
• Provides a one-year cushion when moving

Example

You owned your home for 10 years and designate it as PRE for 8 years:

• Capital gain: $200,000
• Exempt: $200,000 × (1 + 8) / 10 = $180,000
• Taxable gain: $20,000

Reporting Requirements

Since 2016, you must report the sale and designation:

Form T2091

• File with your tax return for year of sale
• Required even if gain is fully exempt
• Failure to file: Exemption may be denied

Schedule 3

• Report the sale on Schedule 3 (Capital Gains)
• Claim the exemption
• Net gain should be zero if fully exempt

Multiple Property Strategy

When you own both a home and cottage:

Option 1: Designate Property with Larger Gain

• Calculate potential gain on each property
• Designate more years to property with larger gain per year
• Use plus-one year on property you sell first

Option 2: Staggered Sales

• Sell one property, use full exemption
• Wait, then sell other property
• Each gets full benefit of ownership years

Example Planning

Own city home (15 years) and cottage (15 years):

• City home gain: $600,000
• Cottage gain: $300,000
• Designate city home for 10 years ($400/year of gain/year)
• Designate cottage for 5 years ($200/year of gain/year)
• Maximize total exemption on larger gain

Change in Use Rules

Converting Principal Residence to Rental

• Deemed disposition at FMV when you change use
• Can elect to defer gain (no immediate tax)
• Election preserves PRE for up to 4 years after moving out
• Cannot claim CCA on the property to preserve election

Converting Rental to Principal Residence

• Deemed disposition at FMV
• Capital gain on rental years is taxable
• Future gain on PR portion is exempt

Land Size Limits

• Half hectare (1.24 acres) included automatically
• Excess land only included if necessary for use and enjoyment
• Rural properties may need to justify larger land portion
• Excess land may be taxable even if house is exempt

Special Situations

Flipping Properties

• Frequent sales may be deemed business income, not capital gains
• Business income is 100% taxable (no 50% inclusion)
• PRE doesn't apply to inventory
• Anti-flipping rule: Properties owned less than 12 months are business income

Inherited Properties

• Receive property at FMV at death (usually)
• Only your ownership period counts for your PRE
• Cannot use deceased's designation years

Separation and Divorce

• Transfer to ex-spouse is tax-free rollover
• Ex-spouse inherits your designation history
• Plan carefully who keeps the home

Common Mistakes

• Not filing T2091: Required since 2016, even for tax-free sales
• Both spouses claiming: Only one PRE per family per year
• Renting part of home: May affect exemption proportionally
• Not tracking ACB: Need accurate cost base for calculation
• Ignoring anti-flipping: Short-term sales may not qualify

Calculating Adjusted Cost Base

Your ACB includes:

• Purchase price
• Land transfer taxes
• Legal fees on purchase
• Capital improvements (not repairs)
• Not deductible: Ongoing maintenance, mortgage interest

Capital Improvements

Additions to ACB:

• Renovations that add value (new kitchen, addition)
• Replacement of major systems (roof, furnace)
• Landscaping that adds permanent value

Provincial Considerations

The PRE is a federal rule, but provincial taxes also apply to any taxable portion:

• Ontario, BC have additional property taxes (speculation, vacancy)
• Quebec has slightly different rules for some situations
• Always consider both federal and provincial implications