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Your home. For many, it likely stands out as the largest purchase you’ve made as an individual or a family. And for some, depending on your circumstances, that may be followed by the purchase of a cottage or other type of Canadian vacation property.

When it comes to home or cottage ownership, the mindset is often buy it, enjoy it, maintain it (and potentially upgrade it over time), and then sell it or transfer it to the next generation. But what’s important to remember is that these properties may significantly increase in value over time, which can create a large tax liability when they get sold or passed down. This is where it may be very helpful to understand how the principal residence exemption (PRE) works, when it applies and how to effectively use it, especially when you own more than one property in Canada.

Note: The following information is an overview of considerations and strategies and may not necessarily apply to your particular financial circumstances. To ensure that your own situation has been properly considered and that action is taken based on the latest information available, you should consult with your qualified tax and legal advisors.

Principal residence: What qualifies?

A principal residence can include your house, apartment, condominium, cottage, chalet, cabin, mobile home, trailer, houseboat or shares in a cooperative building.

For a property to qualify, you have to own it (solely or jointly with one or more individuals), and you or your spouse, former spouse or child must have “ordinarily inhabited” the residence during some part of the year. When it comes to what constitutes “ordinarily inhabited,” the Canada Revenue Agency (CRA) has stated that the requirements can be met even where the owner, the spouse or the children live in the property only for a short period of time. Specifically for cottage or seasonal property owners, this means if you stay there even for a brief vacation, it may be considered ordinarily inhabited for the year.

What about rental properties?

Do you rent your cottage or other secondary property over the course of the year? If so, this may impact whether it qualifies as a principal residence. In general, property you purchase that’s used mainly for earning income is not considered “ordinarily inhabited,” even if you stay in the property for some period of time. However, it is possible to earn incidental income (e.g. rental income) from a property and still claim it as your principal residence.

Capital gains tax

Any principal residence, because it’s owned primarily for your or your family’s use or enjoyment, is considered a personal-use property. When you sell or are deemed to dispose of the property (e.g. when an individual passes away), if the property has increased in value during the time you’ve owned it, you’ll realize a capital gain.

Note: The capital gain will be equal to your sale proceeds minus the adjusted cost base (ACB) of the property. The ACB is normally the purchase price plus any expenses to acquire it (e.g. commissions, legal fees). The ACB also includes capital expenditures, such as the cost of additions and improvements to the property.

In general, you’re required to pay tax on the capital gain resulting from the sale (or deemed disposition) of a personal-use property, unless there’s a specific exemption. That’s where the PRE comes into play, because it can reduce or eliminate this capital gain.

Basic PRE calculations

When you sell (or are deemed to dispose of) your principal residence and there’s a capital gain, this is the formula used to determine the exemption amount:

* You must have been resident in Canada during these years to qualify.

Note: The “1” in the formula represents one additional taxation year of exemption room (called the “one-plus rule”). This accounts for the fact that in some cases, you may dispose of a principal residence in one year and acquire a replacement residence in the same year, and you wouldn’t otherwise be allowed to designate both properties as a principal residence for that year.

The importance of 1981

When designating your principal residence for tax purposes, for years up to and including 1981, it is possible for each family member to designate a different property, and therefore you can make use of the exemption for each property. For ownership years from 1982 and onward, however, you can only designate one principal residence per family unit (spouses and minor children) in a particular year.

Another important year: 1994

In 1994, the government removed the then $100,000 capital gains exemption, but allowed you to file a special one-time election on your 1994 tax return to claim this exemption against capital gains accrued to that date. If you made this election and still own that property today, make sure the revised cost base is taken into consideration when you sell (or dispose of) it.

Applying the exemption

If your primary house and secondary property in Canada both qualify as principal residences, then for any period after 1981 where you owned both properties, you should determine which property, on average, has the largest annual increase in value.

You may be able to maximize the PRE if you designate this property as the family’s principal residence for the maximum number of years. And remember, the maximum number of years a property needs to be designated is the number of years of ownership, minus one (because of the one-plus rule) to fully exempt the gain.

illustrated cabin cottage with fence

Did you know?

Before the year 1972, capital gains weren’t taxed in Canada. So, if you’ve owned your home or vacation property since before 1972, only the increase in value since December 31, 1971, will be used to calculate the gain.

An example

Mrs. Jackson acquired a city home 23 years ago for $70,000 and its fair market value today is $325,000. She also purchased a cottage 18 years ago for $90,000, which her family uses during the summer, and its current fair market value is $260,000. Mrs. Jackson is thinking of selling both properties this year. Since the city home was the only residence Mrs. Jackson owned for the five years prior to purchasing the cottage, she can only designate the city home as her principal residence for these five years.

To figure out the best option for the time period where she can designate either the city home or the cottage as her principal residence, she calculates the average annual increase in value for each home:

  • The city home value increased by approximately $10,625 per year: ($325,000 – $70,000) ÷ 24 years (total years of ownership including the year of sale).
  • The cottage value increased by roughly $8,947 per year: ($260,000 – $90,000) ÷ 19 years (total years of ownership including the year of sale).

To maximize the PRE, Mrs. Jackson should designate the city home as her principal residence for 18 out of the 19 years she owned both properties. (She doesn’t need to designate it for the entire 19-year period because of the one-plus rule.) For the cottage, Mrs. Jackson can designate it as her principal residence for one year and the one-plus rule will allow her to exempt a total of two years’ worth of gains. In other words, the PRE shields the entire capital gain on the city house of $255,000 from taxes and potentially $17,894 of capital gains on the cottage.

How to designate a principal residence

When you sell your principal residence (or are deemed to dispose of it), you have to report the disposition and make the principal residence designation on your income tax return for the year.


This document has been prepared for use by the RBC Wealth Management member companies, RBC Dominion Securities Inc.*, RBC Phillips, Hager & North Investment Counsel Inc., RBC Global Asset Management Inc., Royal Trust Corporation of Canada and The Royal Trust Company (collectively, the “Companies”) and their affiliate, Royal Mutual Funds Inc. (RMFI). *Member – Canada Investor Protection Fund. Each of the Companies, RMFI and Royal Bank of Canada are separate corporate entities which are affiliates. “RBC advisor” refers to Private Bankers who are employees of Royal Bank of Canada and licenced representatives of RMFI, Investment Counsellors who are employees of RBC Phillips, Hager & North Investment Counsel Inc. and the private client division of RBC Global Asset Management Inc., Senior Trust Advisors and Trust Officers who are employees of The Royal Trust Company or Royal Trust Corporation of Canada, or Investment Advisors who are employees of RBC Dominion Securities Inc. In Quebec, financial planning services are provided by RMFI which is licenced as a financial services firm in that province. In the rest of Canada, financial planning services are available through RMFI, Royal Trust Corporation of Canada, The Royal Trust Company, or RBC Dominion Securities Inc. Estate and trust services are provided by Royal Trust Corporation of Canada and The Royal Trust Company. If specific products or services are not offered by one of the Companies, clients may request a referral to another RBC partner. The strategies, advice and technical content in this publication are provided for the general guidance and benefit of our clients, based on information believed to be accurate and complete, but neither the Companies, RMFI, nor Royal Bank of Canada, nor any of its affiliates nor any other person can guarantee accuracy or completeness. This publication is not intended as nor does it constitute tax or legal advice. Readers should consult a qualified legal, tax or other professional advisor when planning to implement a strategy. This will ensure that their individual circumstances have been considered properly and that action is taken on the latest available information. Interest rates, market conditions, tax rules, and other investment factors are subject to change. This information is not investment advice and should only be used in conjunction with a discussion with your RBC advisor. None of the Companies, RMFI, Royal Bank of Canada nor any of its affiliates nor any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. In certain branch locations, one or more of the Companies may carry on business from premises shared with other Royal Bank of Canada affiliates. Notwithstanding this fact, each of the Companies is a separate business and personal information and confidential information relating to client accounts can only be disclosed to other RBC affiliates if required to service your needs, by law or with your consent. Under the RBC Code of Conduct, RBC Privacy Principles and RBC Conflict of Interest Policy confidential information may not be shared between RBC affiliates without a valid reason.

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