What is the principal residence exemption and how does it work?

The principal residence exemption (PRE) is a federal income tax rule that shelters the capital gain on the sale of a home from tax, either partially or fully. If you sell a home that qualifies as your principal residence for every year you owned it, the entire capital gain is exempt and you pay no tax on the profit.

To qualify, the property must be a housing unit — a house, condo, cottage, or even a share in a co-operative housing corporation — that you or a family member "ordinarily inhabited" during the year. A family unit (generally spouses and minor children counted together) can only designate one property as a principal residence per calendar year, so owning two properties forces you to allocate the exemption years across them.

You claim the exemption by filing Schedule 3 of your T1 tax return for the year of sale. The CRA requires you to report all home sales even if you believe the entire gain is sheltered. Failure to report can result in the CRA denying the exemption in an audit. Given the significance of the tax savings involved, a tax professional or lawyer should review your situation if there is any complexity, such as mixed personal and rental use.