As is commonly known, the purchase of a home represents the largest single financial transaction most Canadians will make in their lifetime. However, buying a home represents much more than a financial transaction, however large that transaction may be. The purchase of a home brings with it a sense of both accomplishment and security, as well as the opportunity to build equity in that property over the long term.
In addition to building equity, of course, most home purchasers buy with the expectation that the value of their home will increase over the long term. That’s an expectation that is virtually always realized: while the real estate market always has its ups and downs over everyone’s period of home ownership, the cost of property always increases over the long term.
That increase in the market value of their property is what many homeowners count on to provide not just current financial security, but a retirement nest egg – and often a source of income to supplement Canada Pension Plan and Old Age Security benefits during retirement.
Anyone who was fortunate enough to purchase a home more than 10 or 15 years ago likely now owns a property which has a current market value of many times more than the original purchase price. The real benefit of such asset growth, however, is found in the way such increases in value are treated for tax purposes.
The Canadian tax system is a very comprehensive one, and there are very few sources of employment, business, property, or investment income which escape the tax net. Home ownership is one of those few exceptions. Under general Canadian tax rules, where an asset is sold the increase in the value of that asset over its original purchase price is treated as a capital gain, 50% of which must be included in taxable income and taxed as such. However, where a family home is sold, any increase in value (that is, any gain) is exempt from tax – regardless of the amount of such gain – as long as the home has been used as what is known in tax parlance as a “principal residence” throughout the entire period of ownership. For example, a homeowner who paid $200,000 for a home in 2000 and sold that home in 2026 for $1,000,000 has a gain of $800,000. Assuming that the property was lived in and used as a principal residence for the entire 26 years of ownership, the full $800,000 gain can be received tax-free. If that gain were treated as a capital gain, and taxed as such, approximately $200,000 of the gain would have to be paid as tax on the transaction.
The tax-free status of gains made on the sale of a family home is known in our tax system as the principal residence exemption (PRE), and that exemption has been available to Canadians for many decades. For many years after the introduction of the PRE there were no changes made to the rules governing the availability of the exemption, or the reporting requirements for claiming it. Over the past ten years, however, and especially in 2023, the rules with respect to the availability of the exemption were tightened.
The need for the 2023 changes arose out of a perceived change in the way the housing market operated, resulting from unprecedented increases in the price of residential properties over a relatively short period of time. While there are have always been individuals or companies who purchased properties with the intent of reselling them, perhaps after undertaking renovations, most purchases of residential real estate were made by individuals or families intending to live in them. However, in some Canadian real estate markets over the past 10 or 15 years, it was possible to purchase a property and re-sell it relatively soon thereafter for a very substantial profit. And, where the PRE was claimed on that sale, the entire profit would be received tax-free.
These changes in the housing market led to what the federal government perceived as a situation in which housing was being bought and sold as a commodity rather than for its traditional purpose of providing a home, and that the PRE was being used to avoid the payment of profits made from the “flipping” of properties in a way that was never intended. A secondary effect of such “commodification” of residential real estate was to drive up the price of properties, putting home ownership further and further out of reach for the average Canadian, especially younger people.
For both these reasons, the federal government moved, in 2016 and again in 2023, to make changes to ensure that the principal residence exemption was being used for its intended purpose, and only by those who were entitled to claim it.
The first, smaller, change (which took effect beginning with the 2016 tax year) was an administrative measure which required taxpayers, for the first time, to report any transaction for which the PRE was being claimed. Since then, individuals who are claiming the PRE for a property sale which took place during the year are required to report the sale on Schedule 3, Capital Gains or Losses and must, in addition, complete Form T2091(IND), Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust), designating the particular property as their principal residence.
The second change made by the federal government with respect to the PRE was much more substantive, and aimed directly at those who, in the government’s view, had been misusing the PRE. That change, which took effect beginning in 2023, provides that anyone who sells a residential property which they have owned for less than 365 days is considered to be “flipping” properties. Where that is the case, 100% of any gain made on the sale of the property is included in income and taxed as business income. In other words, not only would the seller of the property not be able to claim the PRE, the gains made on the sale of the property would not be treated as a capital gain (only half of which is included in income for tax purposes) but as business income, the entirety of which is included in income and taxed as such.
The difference in the tax result is best illustrated using the example above. An individual who purchases a property for $200,000 and sells that property for $1,000,000 has a gain of $800,000. The result of the different possible tax treatments of that gain is as follows:
- Where the sale is fully eligible for the principal residence exemption, the total tax payable on the gain is $0;
- Where the gain is treated as a capital gain, the total tax payable on that gain is around $200,000; and
- Where the property sale takes place after 2022, the property was owned for less than 365 days, and the transaction is treated as property flipping, the new rule will apply and the total tax payable on the gain will be about $400,000.
Of course, while most Canadians who purchase a home to live in as a principal residence don’t intend to sell within a year of purchase, life’s circumstances can sometimes dictate a different outcome. Consequently, the rules provide for exemptions from the tax consequences of selling within 365 days of purchase. Generally, those exemptions are available where Canadian homeowners sell their home due to certain specified life events.
The current reporting rules require that anyone who sells a residential property during the year, has owned that property for 365 days or longer, and is claiming the principal residence exemption must report that sale on Part 2 of Schedule 3 of their return for that year. In that section, the taxpayer is required to designate the property which has been sold as their principal residence (while also providing detailed information on that property on Form 2091 (IND)), and to indicate the number of years during the period of ownership the property was used as a principal residence. Where, as is most often the case, the number of years of ownership will be identical to the number of years that the property was used as a principal residence, the entire gain realized on the sale of the property will qualify for the principal residence exemption and therefore be non-taxable.
Where a taxpayer has sold a residential property during the year and that sale took place within 365 days of the date of acquisition of that property, the taxpayer must complete Part 1 of Schedule 3, to determine whether the sale does or does not constitute “property flipping”. The taxpayer is asked to indicate whether they sold a housing unit during the year, and within 365 days of acquiring it. Where the answer to that question is “yes”, the taxpayer can indicate whether the sale was “due to, or in anticipation of” any one or more of nine different “life events”.
That listing of “life events” is quite extensive, and includes all of the following:
- the death of the taxpayer or a related person;
- a related person joining the taxpayer’s household or the taxpayer joining a related person’s household (for example, moving in with a spouse or common-law partner, for the birth of a child, adoption, or care of an elderly parent);
- the breakdown of a marriage or common-law partnership where the taxpayer had been living separate and apart from their spouse or common-law partner for at least 90 days before the disposition;
- a threat to the personal safety of the taxpayer or a related person (for example, domestic violence);
- a serious disability or illness of the taxpayer or a related person;
- the eligible relocation of the taxpayer or their spouse or common-law partner where the taxpayer’s new home is at least 40 kilometers closer to the new work location or school (generally, an eligible relocation allows the taxpayer to carry on business, be employed, or attend full-time post-secondary education);
- the involuntary termination of employment of the taxpayer or their spouse or common-law partner;
- the insolvency of the taxpayer; or
- the destruction or expropriation of the taxpayer’s property (for example, when the property is destroyed due to natural or man-made disaster).
In addition, it is not necessary for such circumstances to have actually occurred prior to the sale; it is sufficient that the sale have taken place “in anticipation of” the particular life event or events. Where these criteria are satisfied, the sale of a residential property within 365 days of its acquisition will be considered to not constitute property flipping, and any gain realized on the sale can qualify for the principal residence exemption (assuming that the taxpayer actually used the property as a principal residence during the part-year that they owned it).
Most Canadians buy a property for the purpose of living in and using that property as a family home/principal residence and such individuals will not encounter any tax consequences when the property is eventually sold. Only in the relatively unusual case where a property is sold within 365 days of its acquisition do the rules apply to deny the homeowner access to the PRE, and then only where that homeowner cannot avail themselves of any of the “life circumstances” exemptions listed above. In the vast majority of cases, homeowners can be assured that the years of making mortgage payments and maintaining and/or making improvements to their home will be “rewarded” by receipt of a substantial financial gain, on which no tax is levied.
More information on the rules governing the sale of a principal residence and how to claim the PRE can be found on the CRA website at https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/personal-income/line-12700-capital-gains/principal-residence-other-real-estate.html.