Capital Gains on the Family Home at Death: Claiming the Principal Residence Exemption

For most Ontarians, the family home is their largest asset and their most important legacy. When that home passes at death, many families assume it transfers tax-free — after all, wasn't the home always exempt?

The answer is: usually yes, but not automatically. The principal residence exemption (PRE) can shelter the entire capital gain on a home at death — but only if it's properly claimed on the terminal return, and only if the property actually qualifies. Understanding the rules before death — and documenting them carefully — is how families avoid a large unexpected tax bill.

How the Deemed Disposition Applies to a Home

When a person dies, the Income Tax Act treats all capital property as sold at fair market value. If you paid $250,000 for your home thirty years ago and it's worth $1,100,000 today, the deemed disposition creates an $850,000 capital gain on the terminal return.

Without the PRE, a significant portion of that gain would be taxable. With the PRE fully applied, the gain can be reduced to zero.

What Is the Principal Residence Exemption?

The PRE is a provision in Canadian tax law that exempts capital gains on a "principal residence" from tax. To qualify:

1. The property must be a housing unit — a house, condo, cottage, mobile home, or even a live-aboard boat, provided you (or your spouse, common-law partner, or child) ordinarily inhabited it during the year.
2. You must designate it as your principal residence for each year in which you want the exemption to apply.
3. Only one property per family unit can be designated as a principal residence in any given year (your spouse and minor children share the same designation, so only one home per couple counts per year).

The "One Plus" Formula

The exemption uses a formula. For most properties, you can designate the home as your principal residence for the number of years you owned it plus one (the "plus one" is a buffer that was added historically to help people who sell one home and buy another in the same year). If the home qualifies for every year you owned it, the entire gain is typically sheltered.

Claiming the PRE on a Terminal Return

This is where many families run into trouble. The PRE isn't applied automatically — it must be formally claimed. The estate trustee, working with an accountant, must:

1. Report the disposition on the terminal return (Schedule 3 — Capital Gains or Losses).
2. Claim the principal residence designation on the appropriate CRA form.
3. Calculate the exempt portion using the PRE formula.

If the home was the deceased's only property and they lived in it their entire ownership period, the full gain is typically exempt and the tax bill is zero. But if they owned the home for some years as a rental, or owned multiple properties at once, the calculation is more complex.

When the PRE Doesn't Cover Everything

Part-Year Rental Use

If the deceased rented out part of their home (e.g., a basement apartment), or rented the entire home for several years before moving back in, those rental years may not qualify for the PRE designation. A portion of the gain becomes taxable.

The CRA has historically allowed a property to switch between rental and personal use without a deemed disposition at the time of the change, provided certain elections are made. But these rules are technical — get accountant advice.

Change-of-Use Rules

If the deceased changed the use of the home from personal to income-producing (or vice versa), there may have been a deemed disposition at the time of the change. This creates an ACB adjustment that affects the gain calculated at death.

Two Properties at Once

If the deceased owned both a city home and a cottage, and both were genuinely inhabited each year, only one can be the principal residence for any given year. Families with two properties need to strategically allocate the designation years between them — a decision with permanent consequences.

What If the Home Passes to a Surviving Spouse?

If the home passes to a surviving spouse (or into a qualifying spousal trust), the spousal rollover applies: the property transfers at ACB and no capital gain is triggered on the terminal return. The PRE question is deferred to when the surviving spouse eventually sells or dies.

The surviving spouse can then claim the PRE on their own return for years they used the property as their principal residence (including years when the deceased owned it, if they were spouses throughout). In practice, this means the full history of spousal principal residence years is available when the spouse eventually sells.

Selling the Home After Death

When the estate sells the home after death rather than transferring it to a beneficiary, the relevant capital gain runs from the fair market value at the date of death (which becomes the estate's ACB) to the sale price. If the estate sells quickly, the gain is typically small.

The estate itself cannot claim the PRE — the exemption belongs to individuals. However, if the home is distributed to a beneficiary who then sells it, that beneficiary may be able to claim the PRE for years they inhabited the property.

Frequently asked questions