Principal Residence Exemption
Principal residence claims are straightforward until they're not, and the technical mistakes cost clients real money. Custom-written for CPAs preparing personal tax returns and advising clients on real estate transactions.
Hugh Woolley
Understand the technical rules that trip up straightforward claims: the gain-per-year optimization when clients own multiple properties, subsection 45(2) elections that preserve four additional designation years, and excess land exceptions based on minimum lot size. You will learn to identify which properties qualify, calculate exemptions correctly when complications arise, and avoid the mistakes that turn exempt gains into taxable income.
Your client hands you a separation agreement and asks: "Are these payments deductible? Can we transfer the house without tax? What about the cottage?"
You scan the agreement. Monthly payments of $3,000 for spousal support. Property division transferring the family home to one spouse, the cottage to the other, RRSPs being split. The agreement was signed three months ago but payments started six months before that. Are the early payments deductible? Does the house transfer trigger a capital gain or does it roll over? If both spouses owned both properties, who gets to claim which one as principal residence? And if you've been doing tax returns for both of them for years, can you even advise on this or are you in conflict?
This session shows you what to look for in separation agreements and how to handle the tax filings correctly:
- Payments are only deductible if the agreement says they're periodic, for maintenance, and the recipient has discretion over how to use them
- The agreement can validate payments made up to one year before it was signed, but not earlier
- Property transfers between spouses roll over automatically at cost unless you elect out on the return
- When couples each own property after separating, the first spouse to file their principal residence designation wins
- Attribution of income stops the year after separation, but capital gains keep attributing until divorce unless both file an election
- Legal fees for establishing or collecting support are deductible, but fees for getting the divorce or dividing property are not
You need to know when you can help both parties and when you cannot. If they want you to prepare both returns and advise on the agreement, you are in conflict the moment their interests compete. One wants to maximize deductions, the other wants to minimize income. The separation creates competing interests that put you in an impossible position unless you choose a side or step back entirely. You also need to recognize what makes support payments deductible. Agreements drafted by family lawyers often use language that sounds like support but fails the tax test. If the payment releases the payor from future obligations, it is a capital payment and not deductible even if the agreement calls it support.
The material walks through real scenarios you will encounter in practice.
Seminar Snapshot
This program will help you understand the principal residence exemption rules, spot issues, and identify valuable planning opportunities. Learn at your own pace with instant access.
Principal Residence Exemption
Course Syllabus
Principal Residence Fundamentals and Qualification Rules
Understanding what qualifies and who can claim
Principal Residence Exemption Overview
- The basic exemption formula: (1 + years designated) / years owned
- When the "1+" rule is available and when it is eliminated for non-residents
- Capital property requirement: when residential property is inventory or adventure in nature of trade
- Mandatory designation requirement since 2016 or exemption denied
Capital Property Requirement
- Hundreds of cases analyzing whether residences are capital property
- Common losing taxpayer patterns: multiple transactions, construction experience, real estate agents, short holding periods
- The flipped property rule: residential property sold within 12 months deemed business income
- Unexpected applications: change of use within 12 months, trust distributions, spousal transfers
Housing Unit and Beneficial Ownership
- What constitutes a housing unit: mobile homes, trailers, houseboats, leasehold interests, co-op shares
- Beneficial ownership versus legal title determines who can claim exemption
- Bare trust reporting requirements from 2023 onwards (T3 return and Schedule 15)
- Co-ownership complexities with duplexes, farm corporations with farmhouse, and commercial properties with residences
Land Size Restrictions and Excess Land Rules
Navigating the one-half hectare limit and exceptions
Subjacent and Immediately Contiguous Land
- One-half hectare (approximately 1 acre) limitation on qualifying land
- Excess land only qualifies if "necessary for use and enjoyment": objective test, not subjective
- Provincial legislation restrictions on subdividing the land
- Property rezoning to permit subdivision eliminates exemption on excess land
Types of Subdivision Restrictions
- Restrictions preventing subdivision without approvals, zoning restrictions on lot size or character of use
- Covenants against subdivision and minimum lot size requirements
- Environmental or heritage restrictions
Minimum Lot Size Exception
- How minimum lot sizes preserve exemption on land exceeding one-half hectare
- Example: property is 10 acres but minimum lot size is 10 acres, entire property qualifies
- Need for municipal confirmation and documentation
- Restriction must exist in year of sale
Two Adjacent Lots
- Purchasing two adjacent lots and building one residence
- If lots cannot be legally combined, only the lot with the housing unit qualifies
- Strategies for combining lots before construction
Ordinarily Inhabited Test and Occupation Rules
Meeting the year-by-year occupation requirement
Ordinarily Inhabited Requirement
- Year-by-year test with part year occupation when purchased late or sold early in year
- Seasonal residences qualify through weekend use; incidental rental income does not disqualify
- Ernest case: one night stay insufficient; Rebus case: garden shed not a self-contained establishment
- Permanent move to nursing home ends ordinary inhabitation
Who Can Ordinarily Inhabit
- Qualifies: taxpayer, spouse/common-law partner, former spouse, or child of the owner
- Does NOT include parents, grandparents, grandchildren, or siblings
- Property owned by parent but occupied by child qualifies for parent's exemption
Proving Ordinary Inhabitation
- CRA requests verification when short ownership periods or suspicious circumstances exist
- Acceptable proof: moving costs, address changes, utility bills, cable/internet installation, furniture purchases
- Neighbour testimony as corroboration when other evidence unavailable
Claiming the Exemption and Multiple Property Strategy
Optimizing exemption claims when clients own several qualifying properties
Principal Residence Misconceptions
- "Principal" does not mean main, chief, or primary residence
- Can ordinarily inhabit multiple properties in same year creating choice
- Gain per year analysis, not absolute gain, determines optimal strategy
Multiple Property Optimization
- Calculating gain per year for each property to determine which deserves designation
- Strategic designation using "1+" rule to take years from one property to fully exempt another
- Cannot revise designations retroactively once filed
Claiming Process and Deemed Dispositions
- Deemed disposition on change in use (personal to rental or vice versa)
- Gift of property, deemed disposition on death, expropriation or destruction
- 21-year deemed disposition for trusts, transfer to spouse with election at FMV
Integrated Units, Duplexes, and Land Used in Business
Handling properties with mixed use or multiple housing units
Integrated Units
- Two or more housing units that cannot be legally severed
- Single housing unit with rental suite versus separate units
Duplexes and Multiple Units
- Land surrounding duplex: complex qualification analysis of whether land relates to both units or specific unit
- Minimum lot size considerations for duplexes
- Legal versus practical severability
Land Used in Business
- Determination based on all circumstances whether property held partly for earning income
- Business use on land may disqualify excess land but does not affect housing unit qualification
Change of Use Elections and Rules
Preserving exemption rights when converting between personal and rental use
Change of Use: Personal to Income-Earning
- Deemed disposition at FMV when personal property becomes rental
- Subsection 45(2) election avoids deemed disposition and cost base remains unchanged
- Can designate as principal residence for up to 4 additional years (no ordinarily inhabit requirement)
- Cannot claim CCA or election becomes invalid
Subsection 45(2) Election Strategy
- Extended designation when relocating for work (indefinite if move back or die)
- Must report rental income but cannot claim CCA
- Making the election by letter attached to return; can rescind later causing deemed disposition
When to Make the 45(2) Election
- Advantageous when no other principal residence to designate or gain per year on existing exceeds new residence
- Better NOT to elect if owned existing residence many years (minimal proration impact)
- Case-by-case evaluation required
Change of Use: Income-Earning to Personal
- Deemed disposition and reacquisition at FMV on conversion
- Subsection 45(3) election for no change of use: must become principal residence, no CCA claimed after 1984
- Election made in year of ultimate disposition
Partial Change in Use
- CRA administrative policy: rental of room or home office, no disposition if no CCA taken
- Substantial change (single family to duplex): deemed disposition whether CCA claimed or not
- Safe approach: make no change in use election for partial conversions
Flipped Property Rules and Foreign Tax Credit Issues
Avoiding business income treatment and optimizing foreign property sales
Flipped Property Rule Mechanics
- Residential property in Canada sold within 12 months: deemed business income
- Life event exceptions (divorce, death, illness, job relocation)
- No principal residence exemption available; very harsh result
Unexpected Flipped Property Applications
- Change of use followed by sale within 12 months or sequential changes within 12-month period
- Transfer to alter ego, spousal, or joint spousal trust with sale or distribution within 12 months
- Rollovers can start 12-month clock running; often too late to fix after the fact
Foreign Tax Credit Interactions
- Many foreign countries tax capital gains on real estate (particularly U.S.)
- Claiming principal residence exemption eliminates foreign non-business income needed for foreign tax credit
- May be wasteful to claim exemption where foreign tax paid
Foreign Tax Credit Optimization Examples
- Full foreign tax situation: no benefit to claiming exemption (waste of exemption)
- Partial foreign tax: claim exemption for fewer years to bring Canadian tax down to foreign tax amount
- Calculation: work backwards from desired Canadian tax level to preserve exemption for future Canadian property sales
Trust Ownership and Special Situations
Principal residence exemption when trusts, estates, or special ownership structures are involved
Ownership by Trust
- Generally trusts cannot claim principal residence exemption after 2016
- Exception: qualifying trust (alter ego, spousal, or joint spousal trust)
- December 31, 2016 valuation date for non-qualifying trusts (subsection 40(6.1))
U.S. Citizens Resident in Canada
- Principal residence exemption available under Canadian tax law
- U.S. worldwide taxation creates complications with partial exclusion under U.S. rules
- Foreign tax credit planning essential to coordinate Canadian exemption with U.S. exclusion
Loss on Residence Owned by Estate
- Loss on principal residence generally not deductible
- Exception: property owned by estate not used by beneficiary may create available capital loss
Borrowing, Probate, and Administrative Matters
Interest deductibility, estate planning, and practical compliance issues
Borrowing and Interest Deductibility
- Purpose of borrowing determines deductibility, not security for loan
- Strategy: sell investments, buy home with cash, then mortgage for investment purposes (Singleton case)
- Timing: allow time between events; case law not totally consistent
Probate Issues
- Joint tenancy with right of survivorship to avoid probate
- Bare trust: no disposition, property forms part of estate, subject to probate
- Actual co-ownership: disposition of 50% at registration with future appreciation only partially protected
- Jackson case (Ontario Supreme Court): cautionary tale requiring excellent legal advice
Cash Back on Home Purchase and Forfeited Deposits
- Realtor commission rebates to buyers: not taxable, reduces purchase price
- Forfeited deposits on failed sales: taxable capital gain to seller, cannot be sheltered with exemption
Common Errors and Best Practices
Avoiding the mistakes that cost clients tens of thousands
Most Common Principal Residence Errors
- Adopting wrong strategy when multiple properties owned (claiming wrong property)
- Failing to consider years when property not ordinarily inhabited (vacant land, construction)
- Excess land issues and minimum lot size exceptions overlooked
- Not making change of use election when appropriate or doing nothing and not reporting
- Failing to claim foreign residence or optimize when foreign taxes payable
- Not noticing client address change during tax season
Best Practices for Tax Season
- Make it habit to ask about address changes and all qualifying properties (cottage, ski chalet, foreign condo)
- Calculate gain per year for optimization when multiple properties exist
- Document ordinary inhabitation especially for short holding periods
- Consider change of use elections before filing and review foreign tax implications before claiming exemption
Meet Your Presenters
Michael Cadesky
Michael Cadesky is the managing partner at Cadesky Tax and a committed contributor to the tax and accounting professions since 1980, earning the title of Fellow from CPA Ontario. He is a past governor of the Canadian Tax Foundation, past chair of STEP Canada and STEP Worldwide, and past chair of the CPA Canada Tax Committee for Small and Medium-Sized Enterprises. Michael is also the co-author of 11 books on tax subjects and the author or co-author of numerous papers and articles on Canadian and international taxation.
Hugh Woolley
Hugh Woolley is an independent tax consultant who has taught income tax for over 30 years for many professional organizations. Hugh has written courses for CPA Canada and over 10 papers for the Canadian Tax Foundation and STEP Canada. From 1990–1992 he worked at the CRA's Rulings Directorate in Ottawa writing "butterfly" tax rulings. Hugh is a past Governor of the Canadian Tax Foundation.
FAQ
When can I access the course?
Immediately upon purchase. All course materials are available on-demand, allowing you to start learning right away.
How long do I have access?
You have 1-year all-access to the course materials. Watch and review the content as many times as you need, at your own pace.
Does the course provide CPD?
Yes. Upon completion, you will receive a verifiable CPD certificate indicating all instructional learning hours and required details.
What's included in the course?
Full video recording of the seminar, plus slides with detailed notes for your reference. Additional resources may be included.
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Yes. Access the course from your computer, tablet, or phone — any device with internet access.