The principal residence exemption
Principal residence — definitions
Section 54 defines a "principal residence" — a housing unit ordinarily inhabited by the taxpayer during the year — which qualifies for the principal residence exemption that eliminates capital gains tax on its sale.
Plain-language explanation
Section 54 defines "principal residence" and works with s.40(2)(b) to eliminate (or reduce) capital gains tax on a home sale.
What qualifies: - A housing unit you or your family ordinarily inhabited at some point during the year - Can be a house, condo, cottage, trailer, or even a leasehold interest - Only one property per family unit may be designated per year (since 1982)
The exemption formula: Capital gain × (1 + years as principal residence) ÷ total years owned = exempt portion
The extra "+1" in the numerator means if you designated the property as your principal residence for every year you owned it, the entire gain is exempt.
Mandatory reporting (since 2016): Even if the full gain is exempt, you must report the disposition on Schedule 3 of your T1 and designate the property on Form T2091. CRA can reassess without limit if you fail to report.
Cottages and vacation properties: Since 1982, only one property per family unit can be designated per year. If you own both a principal residence and a cottage and sell the cottage, you must allocate your years between them — years you designate to the cottage are not available for the city house.
Example
The Park family bought their Toronto home in 2015 for $600,000 and sold in 2026 for $1,400,000 — a $800,000 gain. They lived there every year. Exempt portion: $800,000 × (1+11)/11 = $800,000 × 12/11 = $872,727 — but the exempt gain caps at the actual gain, so the full $800,000 is exempt. No capital gains tax.
Amendment history
Significant changes to this provision. Older versions help you understand rules that applied in prior tax years.
Family unit rule introduced — only one property per family unit (taxpayer, spouse, and minor children) can be designated as principal residence per year. Prior to 1982, spouses could each designate a different property.
Before
Each spouse could designate a separate property as their principal residence
After
One designation per family unit per year; spouses cannot each claim a different property
Mandatory reporting of all principal residence designations introduced. Even if the full gain is exempt, taxpayers must report the sale on Schedule 3 and complete Form T2091. Failure to report allows CRA to reassess beyond the normal 3-year window.
Before
No reporting required when full gain was exempt
After
All home sales must be reported on T1 Schedule 3 + Form T2091, even if fully exempt
Common questions
Do I have to pay capital gains tax when I sell my home? +
Usually no, if the home was your principal residence for all the years you owned it. The principal residence exemption under s.54 and s.40(2)(b) eliminates the tax. But you must still report the sale on your T1 (Schedule 3 + Form T2091) — CRA made this mandatory since 2016.
Can I claim the exemption for my cottage? +
Yes, but only one property per family unit per year can be designated. If you own both a home and a cottage, you need to allocate your years. Many families designate the property with the larger gain as the principal residence for the years it appreciated fastest.
What if I used my home for business (renting out a room)? +
If you rented part of your home or claimed a home office deduction, there may be a partial change-in-use under s.45 that limits the PRE. The rules depend on whether you made a "full vs. partial" change in use. A CPA can help calculate the impact.
Key terms
Related calculators
Related guides
Source: Income Tax Act, RSC 1985, c. 1 (5th Supp.), section 54. — Read the official text on Justice Canada
These summaries are for educational purposes only and do not constitute legal or tax advice. Speak with a CPA for advice on your specific situation.