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Principal Residence Exemption – A Simple Guide

September 14, 2021


One of the great things about owning a house in Canada is that when you sell your house, any price appreciation on the value of your home could be tax free. This is because of something called the “Principal Residence Exemption”.

In this post we will cover the basics of how the Principal Residence Exemption works and some Frequently Asked Questions about (i) owing multiple homes, (ii) change in use (i.e. converting your home into a rental property), (iii) house flipping, and (iv) renovations.


How does the Principal Residence Exemption work?

To put it simply, if you own and live in your home, you could claim the Principal Residence Exemption when you sell your home.

What Qualifies?

The CRA defines a home as: a house, apartment, duplex, condo, cottage, mobile home, or a houseboat – situated on an area that is half an acre or less.

If your home is situated outside Canada, you could still qualify for the Principal Residence Exemption.

Who Can Claim the Exemption?

Only one property per year, per family (spouse or common-law partner and children under 18), can be designated as a Principal Residence. 

Length of Ownership

There is some confusion as to how long you need to live in the home during the year, the CRA’s requirement is quite flexible. You need to live in the home for some time during the year – this period of time does not have to be lengthy provided that the property was not purchased to earn income.

A good example of this are cottages which many Canadians own. A cottage could be a Principal Residence even though you might live there for part of the year.


The Principal Residence Exemption Claim is calculated using a formula outlined in the Income Tax Act which is as follows:

A x (B + 1 / C)

A = Capital Gain

B = Number of years which the property is designated as a Principal Residence

C = Number of years since the property was purchased.

Reporting on your tax return

In order to claim the Principal Residence Exemption, you have to communicate to the CRA that you’re treating your home as a Principal Residence. This is done via reporting the sale on Schedule 3 of your personal income tax return in the year you sell your home.

On your tax return, you will be required to provide: (i) a description of the property (ii) when it was acquired (iii) the proceeds of disposition.

In addition to reporting on Schedule 3, Form T2091 must also be completed.

If you do not report the sale or if you report late, a penalty of $100/month will be imposed up to a maximum of $8,000.

If your home doesn’t qualify

It’s worth mentioning, that if your home doesn’t qualify for the Principal Residence Exemption, you will have to pay capital gains tax.

Capital gains tax on the sale of your home is calculated as follows:

Sale Price of your Home – Purchase Price of your Home * 50% * Your tax rate


Owing Two Properties

Many Canadians own multiple homes. This leads to a dilemma about how to claim the Principal Residence Exemption if you own more than one property – for example, a house in Calgary and a Cottage in Canmore.

Technically, speaking both the house and cottage qualify for the Principal Residence Exemption. However, only one property can be designated under the Exemption by a taxpayer per year (i.e. two properties cannot claim the exemption for the same year).

Generally, speaking it’s always best to designate the property which has experienced the greatest per year increase in value as the Principal Residence.

Let’s take a look at an example to understand this concept:

Home and Cottage Purchase

In 2000, Joe and Jane purchased a home for $100,000

In 2015, Joe and Jane purchased a cottage for $200,000

Home and Cottage Sale

In 2020, Joe and Jane sold their home for $800,000

In 2020, Joe and Jane sold their cottage for $600,000

Gain on Home and Cottage

Joe and Jane’s capital gain on the home is: $800,000 – $100,000 = $700,000

Joe and Jane’s capital gain on the cottage is: $600,000 – $200,000 = $400,000

To start, let determine which property experienced the greatest per year increase in value:

 Gain Per Year

House: $700,000 / (2020 – 2000 +1) = $33,333

Cottage: $400,000 / (2020 – 2015 +1) = $96,667

Therefore, the cottage is the property that has experienced the greatest per year increase in value. The Principal Residence Exemption would be maximized by claiming it for each year the cottage was owned (i.e. between 2015 and 2020). The remaining years of the Exemption will be claimed on the House.

Applying the Principal Residence Exemption Formula


  • Proceeds: $600,000
  • Cost: $200,000
  • Years Designated as Principal Residence: 5
  • Years Owned: 6

($600,000 – $200,000) x (1+5 / 6) = $400,000 

Therefore, the entire gain on the cottage will be exempt.


  • Proceeds: $800,000
  • Cost: $100,000
  • Years Designated as Principal Residence: 16
  • Years Owned: 21

($800,000 – $100,000) x (16+1 / 21) = $566,667

Therefore, $566,667 of the gain on the Home will be sheltered by the Principal Residence Exemption and the remainder of $133,333 ($700,000 – $566,667) will be taxable.


Change in Use of a Principal Residence

Complications arise when a homeowner starts to rent a part of their Principal Residence.

Typically, if you start renting a portion of your home, the CRA considers this to be a partial “change in use” which would result in a capital gain due to a partial disposition of your property. In plain English, this means the CRA considers you to have sold the part of the home you’re renting out.

However, there are some exceptions to this rule which include: (1) the income earned is ancillary to the main use of the principal residence (for example, Airbnb income earned while you’re on vacation), (2) there is no structural change to the property, and (3) you don’t claim CCA.

The Change in Use of a Principal Residence from a home to a rental property, triggers a deemed disposition (i.e. sale) and deemed reacquisition.

For example, if you own a home that is worth $800,000 and you decide to put it up for rent, this would trigger a Change in Use of your Principal Residence which means you’ve sold your house for $800,000 reacquired it for the same price. Therefore, a Change in Use would trigger a capital gain on your home.

There is a way to get out of this by making an election. If you make an election Under ITA 45(2), it would deem that no Change in Use has occurred. The impact of this is that you will avoid paying any tax because there will be no deemed disposition and therefore, no associated capital gain.

However, going forward, you won’t be able to claim CCA on the rental property and you will have to report any rental income earned from the property.

A change in use typically disqualifies a property from being claimed under the Principal Residence Exemption for the years that it is being rented. However, if you’ve filed an election under ITA45(2), you can still use the Principal Residence Exemption for up to four years on the property.


House Flipping

If you’re buying a home to live there for short time, renovate it, then sell it, and repeat this process over and over again – the CRA considers such activity to be a “business” activity.

The profits from the sale of the home will be classified as business income which will be taxed at regular personal income tax rates. House flipping does not qualify for the Principal Residence Exemption.

In a recent court case, a real estate agent was taken to court for purchasing, demolishing, and budling three homes over a six-year period. From 2004 to 2019, the real estate agent purchased three houses, which were demolished, and new homes were built in their place. The real estate agent claimed the Principal Residence Exemption for all three homes and reported a modest amount of income from 2004 to 2019 of between $15,000 to $20,000 per year.

The real estate agent bought his first home in 2004 for $580,000 and sold it in 2006 for $1.4 million which means, he claimed that the entire gain of $820,000 was tax-exempt. He did the same thing for two other homes.

The CRA reassessed the taxpayer for his 2006, 2008, and 2010 personal tax returns (i.e. each year a home was sold) to include unreported business income from the sale of the home.

The lesson here is: don’t abuse the principal residence exemption to shelter tax on real estate “business” activities. You will end up in court and have to pay a hefty tax bill.



If you make any renovations to your property that are considered capital in nature and provide a lasting benefit, such expenses can be added to your Adjusted Cost Base (i.e. added to the purchase price of your home).

Note that these expenses must be for property improvements such as adding a new water system, bedroom, a new deck, etc. Expenses incurred for maintenance to restore the property in its original state, do not count. If this sounds a bit fuzzy, that’s because it requires some judgment.

As a general rule of thumb, if you add anything to your property that wasn’t there before, it can be added to your Adjusted Cost Base. If you replace or renovate something that was already there, it probably won’t qualify.


Let us help you. Do you have questions about the Principal Residence Exemption? Email us:

The accounting and tax information provided in this post does not constitute advice and is meant to be for general information purposes only. The information is current as at the date of this post and does not reflect any changes in accounting and/or tax legislation thereafter. Moreover, the information has been prepared without considering your company or personal financial/tax circumstances and/or objectives.


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