Designating a Property as a Principal Residence
In general, half (50%) of the capital gain realized on the disposition (sale, transfer, exchange, gift, etc.) of a property is taxable.
However, under certain conditions, you can avoid paying tax on all or part of the capital gains by designating the property as your principal residence.
If you designate a property as your principal residence for all the years you owned it, none of the capital gains will be taxable.
If you do not designate the property as your principal residence for all the years you owned it, part of the capital gains will be taxable.
You can designate a property as your principal residence for a given year only if you, your spouse, your former spouse or your child ordinarily used the property as a residence during that year, even if occupation was only short term.
You can designate only one property as your principal residence for a given year.
For more information on the conditions for designating a principal residence, see the section of the guide Capital Gains and Losses (IN-120-V) dealing with a principal residence.
In 2000, Peter and his spouse Mary bought a house for $300,000. In 2010, they bought a cottage for $200,000. They and their children, Felix and Sarah, are the only occupants of the house and cottage.
In 2022, they sell their cottage for $550,000 and learn that their house has a fair market value of $550,000.
They realize a capital gain of $350,000 on the sale of their cottage (sale price of $550,000 minus the purchase price of $200,000). This amount is higher than the capital gain of $250,000 that could potentially be realized if they sold their house ($550,000 minus $300,000). Therefore, they decide to designate their cottage as their principal residence for 2015 to 2022—8 of the 13 years they owned it. They are aware that the law grants an additional year when calculating the tax exemption. After designating the cottage as their principal residence with the CRA, they then complete form TP-274-V.
Calculating the tax exemption
Following the instructions in form TP-274-V, Peter and Mary do the following calculation:
A × B ÷ C, where:
- A is the capital gain realized on the sale of the cottage;
- B is the number of years the cottage was designated as the principal residence plus 1 (additional year granted under the law);
- C is the number of years they co-owned the cottage.
According to the calculation, Peter and Mary can claim a tax exemption of $242,308, the result of $350,000 x (8+1) ÷ 13.
Only the part of the capital gain that exceeds the exemption will be used to calculate income tax. In this case, the excess amount is $107,692 ($350,000 minus the $242,308 exemption). As only half of a capital gain amount is taxable, Peter and Mary will be taxed on only $53,846 (50% of $107,692) in capital gains resulting from the sale of their cottage in 2022.
Impact on the future sale of their house
When Peter and Mary decide to sell their house, they will have to complete form TP-274-V again to designate their house as their principal residence. However, this designation cannot cover the same eight years their cottage was designated as their principal residence.