When you sell your principal residence, any capital gain is generally sheltered where the designation and reporting requirements are met. However, most Canadians never need to think beyond that.
But life isn’t always clean. If your home was ever rented out, converted to business use, or only partially used as your principal residence, there are specific elections under the Income Tax Act that can protect (or defer) your tax exposure. Missing them, or not knowing they exist, can be costly.
This article assumes the property is capital property. The principal residence exemption does not apply where the gain is on income account, including where the federal residential property flipping rules deem the gain to be business income.
Technical details
The principal residence exemption is calculated using a formula that generally considers the number of years the property is designated as the taxpayer’s principal residence. The formula also includes a “+1” year, which can help in a year where one residence is sold and another is purchased. This does not mean a family can freely shelter two properties for the same year. Since 1982, a taxpayer’s family unit can generally designate only one housing unit as a principal residence for each year.
A property also cannot be designated simply because the taxpayer owned it. It must be owned by the taxpayer and ordinarily inhabited in the year by the taxpayer, their current or former spouse or common-law partner, or their child. This is a facts-based test, and there is no set percentage or minimum number of days required. A cottage, for example, may qualify if it is used personally during the year, such as for weekends or vacations. However, a property held mainly to earn rental income may not qualify where personal use is only brief or incidental.
For example:
A couple owns a house in the city and a cottage. Both properties are used personally during the year, and the cottage is later sold. Even though both properties may meet the conditions to be designated as principal residence, the couple does not automatically get the exemption on both properties for the same year. They generally must choose which property to designate for each year, often considering which property has the larger accrued gain per year.
Note: the principal residence exemption generally includes the land under and around the home. However, where the property is larger than one-half hectare, the excess land may not qualify unless it is necessary (not just desirable) for the use and enjoyment of the home as a residence.
First: What to collect – Information you (or your accountant) will need
These situations require documentation that spans years, sometimes decades. Don’t wait until you’re selling to pull this together.
Property basics:
- Original purchase price and closing costs,
- Date of purchase,
- Lot size, survey, or property parcel details (especially for rural/acreage properties), and
- Legal description (address).
At the time of any change in use:
- Fair market value on the date of change (obtained through an appraisal),
- Floor plan or square footage breakdown, by use (owner-occupied vs rental/business),
- Date the change occurred, and
- Whether any structural changes were made.
Ongoing, while renting or running a business from the property:
- Annual rental income and expense records,
- Confirmation that no CCA was claimed (allowed), and
- Any years where another property was designated as PR.
At the time of sale:
- Final sale price and closing costs (e.g., legal fees, real estate commissions), and
- The square footage allocation used (be consistent with what was used at the change in use).
Note: if you sell, or are considered to have sold, a property that was your principal residence at any time, the disposition must generally be reported on Schedule 3 and Form T2091, even if the principal residence exemption eliminates the gain.
You’re Moving Out and Renting Your Home – Subsection 45(2)
A full change from personal use to income-producing use causes a deemed disposition and reacquisition at fair market value at the time of the change, per the change-in-use rule 45(1). The gain accrued up to that date is calculated at that date, and the principal residence exemption may shelter all or part of that gain (depending on the designation years).
A 45(2) election turns off that deemed change-in-use disposition. Where the taxpayer is deemed not to have begun using the property to earn income – effectively deferring the recognition of the gain that would otherwise arise on the change in use from personal to either rental or business use, and may allow the property to be designated as the taxpayer’s principal residence for up to four tax years.
Key conditions while the election is in effect:
- No other property is designated as your principal residence during those years,
- You are a resident or deemed resident during the years being designated,
- No capital cost allowance (CCA) is claimed (allowed) on the property, and
- Rental income and expenses are reported annually.
Note: If the taxpayer is a non-resident in a particular year, the designation requires separate analysis.
Can you extend the election period?
Sometimes. The usual four-year limit may be extended where the taxpayer, or their spouse or common-law partner, moves because their place of employment is relocated. To qualify, the employer must generally be unrelated, the original home must be 40 km farther from the new workplace than the taxpayer’s temporary residence, and the taxpayer must resume ordinarily inhabiting the original home while still employed by that employer or before the end of the year after that employment ends.
How do I make the election?
No special form is required, just a letter filed on time. Attach a signed letter to your T1 personal tax and benefits return for the year the change in use occurs. The letter must describe the property and state that you are electing under subsection 45(2) of the Income Tax Act.
For example:
You purchased a Calgary condo in 2018 for $400,000 and lived in it as your principal residence. In 2024, you moved to Vancouver and began renting the Calgary condo. At that time, the condo is worth $550,000.
Without a 45(2) election: the change to rental use generally triggers a deemed disposition at fair market value. You are treated as having disposed of the condo for $550,000 and immediately reacquired for $550,000. The $150,000 accrued gain may be reduced or eliminated by the principal residence exemption if the condo is designated for the eligible years, up to the change in use. Future appreciation after the 2024 conversion is generally treated as rental-property appreciation.
With a 45(2) election: the 2024 deemed disposition is avoided, so there is no fair-market-value bump to the property’s cost base at that time. Rental income must be reported. CCA should not be claimed for tax years covered by the election. Claiming CCA can rescind or undermine the election and may prevent CRA from accepting a late-filed 45(2) election. If the conditions are met, the condo may still be designated as a principal residence for up to four rental tax years while the election is in force. When the condo is later sold, the PRE calculation is applied based on the total gain and the years that can be designated.
Note: The CRA’s published guidance describes the election as a signed letter attached to the return; where the return is filed electronically, confirm current CRA submission procedures or mail/upload the signed election separately.
Are late 45(2) elections accepted?
Sometimes. A 45(2) election should normally be filed with the tax return for the year the property’s use changed. However, CRA may accept a late-filed 45(2) election under the taxpayer relief rules, because subsection 45(2) is a prescribed election under section 600 of the Income Tax Regulations. Relief is discretionary (not guaranteed), must generally be requested within the applicable 10-year period, and is usually subject to a penalty. The CRA will not accept a late 45(2) election if CCA has been claimed (allowed) on the property.
You’re Moving into a Former Rental Property – Subsection 45(3)
This is the reverse scenario. You convert a rental or business property into your new principal residence. Normally, a deemed disposition occurs at fair market value on the date of conversion. A 45(3) election lets you defer reporting that disposition until you actually sell and permits the taxpayer to designate up to four qualifying prior years as the taxpayer’s principal residence.
Key restriction while the election is in effect:
You cannot make this election if you, your spouse or common-law partner, or a trust in which either of you is a beneficiary has claimed CCA on the property for any tax year after 1984 and on or before the date of change in use. CRA’s says the 45(3) election is not possible where CCA was claimed (allowed) in the relevant period.
How do I make the election?
A 45(3) election is made by sending CRA a signed letter. Unlike a 45(2) election, it is not usually filed with the return for the year the property first becomes your principal residence. Instead, it is generally filed with the tax return for the year the property is ultimately sold or otherwise disposed of – unless CRA formally requests the election earlier. If CRA does request it, the election must be filed within 90 days of that request.
Note: the legislation requires the taxpayer to notify the Minister in writing by the earlier of 90 days after the CRA sends a demand for the election and the filing due date for the year the property is actually disposed of.
For example:
You purchased a house in 2015 for $500,000, immediately renting it to tenants. In 2023, you moved into the house and began using it as your principal residence. At that time, the house was worth $750,000, and no CCA was ever claimed (allowed).
Without an election: the change from rental use to principal-residence use generally triggers a deemed disposition at fair market value. You are treated as having disposed of the property for $750,000 and immediately reacquired it at that value, which may result in a taxable capital gain.
With a 45(3) election: the deemed disposition can be deferred until the property is later sold. If the conditions are met, the election may also allow the property to be designated as your principal residence for up to four tax years before you moved in, even though you did not ordinarily inhabit it during those years.
Only part of your home changes – Partial change in use
For changes in use that occur on or after March 19, 2019, the 45(2) and 45(3) elections may be available for partial changes in use, not only full-property conversions. This can matter where only part of a home begins, or stops, being used to earn income. The result depends on whether the income-producing use is minor and ancillary to the home’s main use as a residence, or whether the change is more substantial or permanent.
When CRA may not apply the deemed disposition rule
CRA’s administrative practice is generally not to apply the deemed disposition rule where the income-producing use is ancillary to the main use of the property as a principal residence, there is no structural change to the property, and no CCA is claimed (allowed). In those cases, CRA may consider the whole property to retain its nature as a principal residence.
This can include situations such as:
- Renting one or more rooms in the home,
- Operating a small home-based business, or
- Using a workspace in the home.
Rental and/or business income should still be reported, and related expenses may be deductible, but CCA should not be claimed if relying on this CRA position.
When a partial change in use may trigger a deemed disposition
Where the partial change in use is substantial and more permanent, the deemed disposition rule may apply to the portion of the property that changed use.
This can include converting part of a home into:
- A store,
- A self-contained rental unit, or
- Separate business premises.
In those cases, the deemed proceeds and reacquisition cost are generally based on the converted portion’s share of the property’s fair market value, often using a reasonable allocation such as square footage.
For changes on or after March 19, 2019, a subsection 45(2) election may be available where part of a principal residence is converted to income producing use, and a subsection 45(3) election may be available where part of an income producing property is converted to principal residence use. These elections may defer the deemed disposition that would otherwise arise.
For example:
You own a home purchased in 2011 for $400,000, in December 2026, you convert 50% of the home into a self-contained rental suite. Fair market value at change in use is $1,000,000.
Without a 45(2) election: Report the following information on Form T2091 of your T1 tax and benefits return:
- Rental portion, cost: $200,000 (=50%*400,000),
- Deemed disposition on rental: $500,000 (=50%*1,000,000),
- Deemed disposition gain on rental portion: $300,000,
The $300,000 deemed gain may be eliminated by the principal residence exemption, assuming the property is eligible and designated for the relevant years.
However, if you file a 45(2) election with the 2026 tax return, the deemed disposition on the converted rental portion is deferred. The years the conversion may be designated based on ordinary habitation, and the election may allow the converted rental portion to continue qualifying for up to four additional years while rented.
Then, if you sell in 2028 for $1,500,000:
- Rental portion proceeds $750,000 (=1,500,000*50%), less
- Original allocated cost $200,000, =
- Gain before the principal residence exemption $550,000.
If the property is sold in 2028, the converted rental portion may still be fully sheltered because the taxpayer can potentially designate the ordinary habitation years plus the rental years covered by the 45(2) election – assuming no other family-unit property is designated. The gain is not automatically taxable just because part of the home was rented.
For example, if sold in 2032, the part of the home you continued living in may remain fully sheltered, but the converted rental portion may become taxable once the four year election period is exceeded:
- Total ownership: 2011–2032 = 22 years.
- Years that may be designated for the converted rental portion = 20 years:
- Years you lived in the home: 2011-2026 = 16, plus
- Four additional years potentially covered by the 45(2) election: 2027-2030 = 4.
- Principal residence exemption formula on converted rental portion, of the rental portion gain = (1 + 20) / 22, and
- Unsheltered portion, of the rental portion gain: 1 / 22.
Finally: Hold on to everything
Once an election is filed or a principal residence designation is made, the supporting documentation doesn’t expire when you sell – it may be needed long after. The CRA can reassess a tax year up to three years from the date of the original notice of assessment (longer, in cases of misrepresentation or fraud). In practice, retaining records for six years from the end of the tax year to which the records relate is the safe standard. However, for long-held properties, documents should be retained for as long as needed to support the eventual sale and subsequent CRA review period.
This includes:
- Copies of any 45(2) or 45(3) election letters and the T1 returns they were attached to,
- Schedule 3 and Form T2091 filings included in the T1 from the year of sale,
- Capital improvements and/or renovations and related invoices,
- The appraisal obtained at the time of change in use,
- Your square footage or room-count allocation documentation,
- Annual rental income and expense records (T776) for all rental years,
- Purchase and acquisition costs (e.g., transfer taxes), and
- Closing costs on sale (e.g., real estate commissions and legal fees).
If your situation involved a spouse or common-law partner, both sets of records should be retained – including each person’s individual election letter and the T1 it was filed with.
Provincial considerations
This article focuses on the federal income tax rules for principal residences, changes in use, and the principal residence exemption. Provincial and local rules may also apply and are not covered in detail here.
A few examples (relevant as of May 2026):
- Quebec residents file a separate provincial income tax return through Revenu Quebec, and principal residence dispositions may require separate Quebec reporting or forms.
- British Columbia has a separate home flipping tax that may apply to profits from certain B.C. residential property dispositions where the property was owned for less than 730 days.
- Other provinces may have other property-related rules that apply; these should be reviewed separately based on where the property is located.
