Selling Your Home to Downsize: Capital Gains and the Exemption

The short answer

For most people the principal residence exemption means selling the family home to downsize does not produce a tax bill. The Canada Revenue Agency (CRA) says that if the property was solely your principal residence for every year you owned it, you do not have to pay tax on the gain. The part that surprises people is the paperwork, because the sale still has to be reported.

This post explains how the principal residence exemption works when you downsize, using the CRA’s own pages. It is general information, not tax advice. Your accountant should confirm how the rules apply to your situation before you list. Our downsizing in Markham guide covers the wider process of selling, buying smaller and sequencing the two closings.

What counts as a principal residence

The CRA says a property is your principal residence for a year only if it meets all of these conditions:

• It is a housing unit, a leasehold interest in a housing unit or a share of the capital stock of a co-operative housing corporation.
• You own it, alone or jointly.
• You, your current or former spouse or common-law partner or any of your children lived in it at some time during the year.
• You designate it as your principal residence.

The CRA’s Income Tax Folio S1-F3-C2 describes a housing unit broadly. It can be a house, an apartment or unit in a duplex, an apartment building or a condominium, a cottage, a mobile home, a trailer or a houseboat. That matters for downsizers who are thinking about the home they are buying as well as the one they are selling.

The folio also says that even if a person lives in a housing unit for only a short period in the year, this is enough to meet the requirement of ordinarily inhabiting it.

How much land is covered

A principal residence includes the land the home stands on and any adjoining land that can reasonably be regarded as contributing to your use and enjoyment of it. The CRA limits that amount of land to half of a hectare, which is 1.24 acres, unless you can show that more land was needed for the use and enjoyment of the home.

It is worth a conversation with your accountant if you own a larger rural or estate-style property and are selling it to move into something smaller.

Why you still report the sale

This is the step people miss. The CRA says that for 2016 and later tax years it will only allow the principal residence exemption if you report the sale and the designation. If you sold property in the tax year that was at any time your principal residence, you complete two forms with your return:

1. Schedule 3, Capital Gains or Losses
2. Form T2091(IND), Designation of a Property as a Principal Residence by an Individual

This applies even when the whole gain is exempt and nothing is owing. The reporting is what claims the exemption.

If the designation is forgotten in the year of the sale, the CRA says it is very important to ask it to amend your return. Late designations can bring penalties, so do not leave this until the following spring if you notice a gap.

One home per family per year

For years after 1981 the CRA says only one property may be designated as a family’s principal residence for a particular year. The folio defines the family unit to include spouses and common-law partners, unless they are separated and unmarried children under 18. For a single person it includes their parents and their unmarried siblings under 18.

This is where a second property changes the picture. A family that owns a house in Markham and a cottage cannot designate both for the same year. If you are downsizing out of a house and also own a cottage or a second property, speak with an accountant about which years to assign to which property before you sell either one.

The formula behind the exemption

When a home was not your principal residence for every year you owned it, the exemption covers only part of the gain. The CRA folio gives the calculation as the gain multiplied by the number of years designated plus one, divided by the number of years owned.

The extra year is there because you can sell one home and buy another in the same year. Without it, a family moving between two homes in a single year could lose a year of coverage on one of them.

A worked example

The numbers below are round and made up to show the arithmetic. They are not a prediction and they are not a real sale.

Suppose a homeowner sold a home for a gain of $200,000. They owned it for 10 years and designated it as their principal residence for 8 of those years. The other 2 years, they designated a different property.

Step	Figure
Years designated plus one	8 + 1 = 9
Years owned	10
Share of the gain that is exempt	9 divided by 10 = 90 percent
Exempt portion of the gain	$180,000
Portion of the gain that stays taxable	$20,000

How the remaining $20,000 is taxed depends on the CRA’s capital gains rules at the time and on the rest of the person’s return. An accountant can calculate that for you. If the home had been the principal residence for all 10 years, the formula would give 11 divided by 10, which is more than the whole gain, so the entire gain would be exempt.

Where downsizers run into trouble

Most downsizers sell one home that was lived in for the whole time they owned it. Their year-by-year designation is simple. A few situations call for more care:

• You kept a cottage or second property and want to use the exemption on one home for some years and the other for the rest.
• The home was rented out for part of the time. Our guide to moving a parent into a retirement home explains the change in use rules and the subsection 45(2) election, so we will not repeat them here.
• The house was held in a family member’s name or jointly with someone who did not live there.
• You are selling an inherited home. Our page for estate sales explains how we help families through that process. An accountant should advise on the tax side.

In each case the CRA looks at the facts for each year, so keep records of when you bought, when you moved in and any period when the home was not your residence.

What to do before you list

1. Write down the date you bought the home and the dates you lived in it.
2. List any other property your family has owned during those years.
3. Ask an accountant whether the home was your principal residence for every year and whether any part of the gain could be taxable.
4. Ask the accountant to prepare Schedule 3 and Form T2091(IND) when the sale closes.
5. Keep the purchase and sale statements from your lawyer with your tax records.

If you are weighing costs before you decide, our Markham downsizing costs breakdown covers the bills that arrive at closing. For how we work with sellers, see our sellers page.

Next steps

The principal residence exemption is usually good news for a downsizer, but it only works if the sale is reported correctly. Confirm your own year-by-year position with an accountant before you sign a listing agreement. If you would like to talk through timing and what a sale in Markham might involve, contact us.