Selling Your Home? Understanding the Principal Residence Exemption – A Complete Guide by a Montreal CPA Firm Near You

Introduction

Selling your home is one of the largest financial transactions most Canadians will ever make. What many homeowners do not realize is that since 2016, the sale of a principal residence MUST be reported to CRA, even if the gain is fully tax-free. CRA closely reviews real estate sales to detect improper claims, flipping activity, partial exemptions, and mixed-use properties. The Principal Residence Exemption (PRE) is one of the most valuable tax benefits available to Canadians, but it comes with strict rules about occupancy, land size, rental use, renovations, and periods of non-residency. This guide explains exactly how the PRE works and how to avoid costly CRA reassessments.

Legal and Regulatory Framework

The Principal Residence Exemption is governed by section 40(2)(b) of the Income Tax Act and its related definitions under section 54. To qualify, a property must be ordinarily inhabited by you, your spouse or common-law partner, or your children. A principal residence can include a house, condo, cottage, trailer, mobile home, or some co-ops. Only one property per family unit can be designated per year. The exemption must be reported using Schedule 3 and Form T2091 (IND) when applicable. Failing to report can trigger penalties, loss of exemption, or CRA treating the sale as unreported income.

Key Court Decisions

In Golden v. The Queen, the court denied the PRE when the taxpayer failed to prove actual occupancy. In Sangha v. Canada, CRA successfully argued that the taxpayer was flipping houses, not living in them, resulting in business income tax instead of a PRE. In Moore v. The Queen, a large acreage property exceeded the allowable land size for PRE, reducing the exemption. In Bruneau v. Québec, a unit used partly for Airbnb rental triggered a partial loss of exemption. These cases show how easily the PRE can be reduced or denied if rules are misunderstood.

Why CRA Focuses on Principal Residence Claims

Real estate transactions are one of CRA’s highest enforcement priorities. CRA matches land registry data, mortgage files, property tax rolls, utility records, and platform rental activity against tax filings. Red flags include frequent sales, short holding periods, renovations immediately before sale, partial or full rentals, lack of personal use, high income inconsistent with lifestyle, and use of CCA (depreciation) on the home. Failure to report the sale at all is an automatic audit trigger.

How the Principal Residence Exemption Works

The PRE eliminates capital gains tax on the sale of your home for every year it was designated as your principal residence. The formula is: Exempt Portion = (Years Designated + 1) / Years Owned × Gain. The +1 year rule acknowledges situations where you sell one residence and buy another in the same year. If the property was not your principal residence for all years, only a portion is exempt. Any non-exempt portion is subject to capital gains tax at 50% inclusion.

When the PRE Is Reduced or Denied

1. Short-Term Ownership or Flipping

If CRA believes you bought the property to flip for profit, the PRE may be denied and income may be classified as business income.

2. Rental or Airbnb Use

If part of the property was rented, only the personally used portion qualifies. Extensive rental reduces or eliminates the exemption.

3. Claiming CCA

Once you claim depreciation on any part of your home, that portion permanently loses the PRE.

4. Large Land Area

Land over half a hectare is not fully eligible unless required for the ordinary use and enjoyment of the residence.

5. Change in Use

Moving out and renting the property may trigger a deemed disposition unless elections are filed.

6. Non-Residency Periods

Years spent living outside Canada or not occupying the home may reduce exemption.

Reporting Requirements

Since 2016, you must report: the address, year of acquisition, proceeds of disposition, and designation as principal residence. Form T2091 may be required when the exemption is not full. Failure to report can result in penalties of up to $8,000, and CRA may reassess outside the normal limitation period for unreported dispositions.

Mackisen Strategy

At Mackisen CPA Montreal, we guide homeowners through proper PRE claims, analyze mixed-use situations, allocate rental vs personal portions, evaluate whether CCA was claimed, prepare Schedule 3 and Form T2091, assist with change-of-use elections, and defend principal residence claims during CRA and ARQ audits. We also review real estate portfolios to identify tax-efficient strategies before selling.

Real Client Experience

A Montreal homeowner who Airbnb-rented a basement suite avoided a partial denial after we documented personal use and recalculated allocation. A real estate investor audited for flipping was able to maintain PRE on one property after we proved ordinary habitation. A family with a large country home avoided exemption reduction by demonstrating that the land was required for access and enjoyment. A taxpayer who failed to report the sale of a condo avoided penalties after we filed a late designation with supporting documentation.

Common Questions

Do I have to report the sale even if no tax is owed? Yes—mandatory. Can a cottage qualify as a principal residence? Yes—if ordinarily inhabited. Can I designate two homes in the same year? No—one per family unit. Does Airbnb affect the exemption? Yes—partial rental use reduces PRE.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps homeowners, investors, and families properly claim the PRE, avoid CRA red flags, and prevent costly reassessments. Whether you are selling a condo, duplex, cottage, or multi-unit property, we ensure your exemption is accurate, compliant, and audit-proof.