Principal Residence of a Deceased Person and Capital Gains Tax in Canada

If the person who died owned a home, you may be wondering whether the estate owes tax on it. For many families the answer is no or very little, but the home still has to be handled correctly on the final return.

This article explains how the principal residence exemption fits with the deemed sale at death, what changes if the family also owned a cottage, and how a later sale by an heir is taxed.

This article covers Canadian federal tax law, which applies in every province.

The deemed sale at death

On death, a taxpayer is deemed to have disposed of each capital property immediately before death for proceeds equal to its fair market value. Gain or loss is fair market value on the date of death minus the adjusted cost base, reported on Schedule 3 and line 12700 of the final return.

Fair market value is usually the highest dollar value you can get for property in an open and unrestricted market, and the CRA tells owners to keep records of it. A written appraisal is a common way to document value, though the evidence needed depends on the situation.

How the exemption applies

A gain on the deceased's home may be fully or partly exempt, but the property must still be reported on Schedule 3 and designated on Form T1255. The designation covers only years up to the date of death. The CRA guide also refers to Form T2091(IND) for designating a principal residence.

The gain is fully exempt if the home was the principal residence for all years owned, or all but one, and neither the owner nor a family member designated any other property as a principal residence for those years. The formula in section 40(2)(b) of the Income Tax Act is gain A − (A × B/C) − D, where B counts the years the property was the principal residence and C counts years of ownership after acquisition.

Cottages and second properties

A cottage or second property cannot be designated for a year in which another property of the family unit is designated. Where a family owns a home and a cottage, only one can be designated for each year, so part of the deemed gain on the other may be taxable on the final return.

When the house is sold later

A person who acquires the property because of the death is deemed to acquire it at fair market value at the time of death, which sets their adjusted cost base. A beneficiary who later sells generally calculates gain or loss as the sale price minus the fair market value reported on the final return. Current expenses such as maintenance and repairs cannot be added to the adjusted cost base.

• If the estate sells after death, gains on that sale are reported on the estate's T3 return, not the final return.
• If the property passes to a spouse or common-law partner resident in Canada, the rollover can apply and the spouse takes the deceased's cost amount instead.
• The legal representative can elect out of the rollover for a property.

Whether the exemption helps an heir after death depends on whether they can use their own principal residence designation, so ask an accountant before a sale.

What to do next

• Gather the purchase documents and any records of improvements to support the adjusted cost base.
• Get a record of the home's value at the date of death.
• List every other property the family unit owned, including any cottage.
• Report the home on Schedule 3 and complete the principal residence designation form.
• Keep the date-of-death value on file for whoever sells the home later.

If there is a cottage, a rental period or a sale before the final return is filed, a lawyer or accountant can help sort out which property to designate.

Frequently asked questions