Capital Gains Tax When You Sell a Rental Property or Cottage in Ontario

Selling a rental property or cottage in Ontario almost always triggers a capital gain — and with it, a tax bill. Yet many property owners are surprised to learn that the tax owing can be reduced, and sometimes significantly, by properly calculating your adjusted cost base, applying any available exemptions, and offsetting losses. Understanding capital gains tax when selling a rental property in Ontario before you list the property gives you time to plan rather than scramble at tax time.

This article walks through the core concepts: what triggers a capital gain, how to calculate the gain, how the inclusion rate works, the difference between selling a rental versus a cottage you've personally used, and what your lawyer and accountant each handle in the process.

What Triggers a Capital Gain?

A capital gain arises when you sell (or are deemed to have sold) a capital property for more than it cost you. For real estate, the triggering events include:

• An arm's-length sale to a buyer
• A transfer to a family member, even as a gift (the Income Tax Act generally deems a disposition at fair market value)
• A change in use — for example, converting your principal residence into a rental, or vice versa
• Death (the estate is deemed to have disposed of most capital property at fair market value)

The gain is the proceeds of disposition minus the adjusted cost base (ACB) and any selling costs (legal fees, real estate commissions, land transfer tax paid on acquisition, and similar expenses).

Calculating the Adjusted Cost Base (ACB)

The ACB is not simply what you paid for the property. It is the original purchase price plus certain additions that increase your investment in the property. Common additions to the ACB of a rental property or cottage include:

• Legal fees and land transfer tax paid when you bought the property
• Capital improvements (a new roof, addition, or finished basement — not routine maintenance or repairs)
• Costs to acquire the property such as surveying fees

What does not increase the ACB: ongoing repairs, mortgage interest, property taxes, and property management fees are current expenses, not capital additions — they reduce rental income but do not raise the ACB.

Keeping thorough records of every capital improvement over the years you own the property can meaningfully reduce the capital gain when you eventually sell. The Canada Revenue Agency (CRA) can ask you to substantiate these amounts, so receipts and invoices matter.

How the Inclusion Rate Works

Canada does not tax 100% of a capital gain. Instead, a portion of the gain is included in your taxable income — this portion is called the inclusion rate. Only that included portion is taxed at your marginal income tax rate for the year.

Important: the inclusion rate is set by Parliament and has changed more than once over the history of Canadian income tax. It can change again. This article does not state a specific inclusion rate because that rate should be verified directly with the CRA or a qualified accountant at the time you are planning a sale. What matters conceptually is that your entire capital gain is not taxed — only the included portion is added to your income.

Selling a Rental Property vs. a Cottage You've Used Personally

These two scenarios look similar on paper but are treated differently because of the principal residence exemption (PRE).

Rental Property

A property used exclusively as a rental from the day you bought it does not qualify for the PRE. The full capital gain (proceeds minus ACB minus selling costs) is brought into income at the applicable inclusion rate. There is no personal-use carve-out.

If you claimed capital cost allowance (CCA) — depreciation — against rental income in prior years, a portion of the gain may be recaptured and included as ordinary income rather than as a capital gain. Recapture is taxed at a higher effective rate than a capital gain, so this is an important planning consideration before claiming CCA on a rental property.

Cottage or Recreational Property Used Personally

A cottage you have used as a personal residence — even seasonally — may qualify for the PRE for the years it was your principal residence. The exemption formula shelters one year of the gain for each year the property was designated as your principal residence, plus one additional year under the standard formula.

The practical result: if you owned the cottage for 20 years and it qualifies as your principal residence for 10 of those years, roughly half the gain could be sheltered. The exact calculation depends on your specific facts and the years designated. You can only designate one property per family unit as a principal residence for any given year.

Partial use: if the cottage was also rented out for part of the time, the CRA may restrict the PRE depending on whether a change in use occurred and whether CCA was claimed. These situations benefit from a conversation with an accountant before you sell.

Capital Losses and Offsetting Gains

If you sell another capital property at a loss in the same year — or carry back a loss from a prior year — you can use capital losses to offset capital gains. Only allowable capital losses (the includable portion of a capital loss) can be applied against taxable capital gains (the includable portion of a gain).

A net capital loss that exceeds your gains in a year can generally be carried back three years or carried forward indefinitely to offset future capital gains. It cannot be used to shelter other income such as employment income.

Reporting the Gain: Schedule 3

Capital gains and losses are reported on Schedule 3 of your T1 personal income tax return. You report the property description, proceeds of disposition, ACB, and outlays and expenses. The net taxable capital gain flows to line 12700 of your T1 and is included in your taxable income for the year.

If the property is a cottage for which you are claiming the PRE, you must also complete the required designation form and include it with your return for the year of sale.

What Your Lawyer Does vs. What Your Accountant Does

Many property owners are unsure which professional handles which part of a sale.

Your real estate or tax lawyer handles:

• Reviewing or drafting the agreement of purchase and sale
• Conducting title searches and managing the closing
• Calculating and remitting any HST obligations (applicable in some rental property transactions)
• Advising on structuring issues with legal implications

Your accountant handles:

• Calculating the ACB and the resulting capital gain
• Determining the correct inclusion rate and tax owing
• Claiming the PRE and completing the designation
• Advising on CCA recapture and filing Schedule 3

The two professionals work together on more complex situations — for example, an estate sale, a transfer to a corporation, or a sale involving a change-of-use election. Starting with both on side before you sign anything gives you the most planning room.

Frequently asked questions