Does the Principal Residence Exemption Apply to a Cottage in Canada?

Many Canadians own a home and a cottage. When one is sold, a common question is whether it can be tax-free, and whether you must choose between the two.

The rules let you choose, year by year, but only one property per family unit can be designated for any given year. This article explains how that works and how to think about the choice. Your facts matter, so confirm the details with a lawyer or accountant.

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

Can a cottage be a principal residence?

Under the definition of principal residence in section 54 of the Income Tax Act, the property must be a housing unit owned by the taxpayer and ordinarily inhabited in the year by the taxpayer or a spouse, common-law partner, former spouse or partner, or child.

Whether a unit is ordinarily inhabited is a question of fact. Even a short period of occupation in the year can be enough, but where the main reason for owning is to earn income, a brief occupancy generally will not qualify.

One property per family unit per year

Only one property per family unit can be designated as a principal residence for each year from 1982 onward. For 1993 and later years, the family unit is you, your spouse or common-law partner and your unmarried children under 18.

• A spouse or common-law partner separated for the whole year under a court order or written separation agreement is not in the same family unit for that year.
• For 1982 to 1992 the one-property rule applied only to spouses.
• An unmarried person under 18 with no spouse, partner or child has a family unit that also includes their parents and unmarried siblings under 18.

Choosing which years go to which property

The exempt portion of the gain under paragraph 40(2)(b) of the Income Tax Act is A − (A × B/C) − D. A is the gain otherwise determined, B is one plus the number of years ending after the acquisition date for which the property is designated, and C is the number of years ending after acquisition in which you owned the property. Where you were non-resident in the acquisition year, B counts only years of Canadian residence. D is a further amount that depends on your facts, so an accountant can confirm it for you.

You may designate each home for different years, as long as no year is designated for two properties. When one is sold, you generally compare the gain per year of ownership on each property, because the designation lets you shelter the one with the larger gain for more years. The plus-one year can make the whole gain exempt if the home was the principal residence for all years owned except one. The CRA explains the plus-one year as letting you designate the sold home for the year of sale when you also bought another home that year, but it is not available if you were not a Canadian resident in the year you bought that other home, and a non-resident generally cannot use the exemption for non-resident years. Each property is calculated on its own, so a lawyer or accountant can help model the best split.

Years in which the property was vacant land count in C but not in B, so they reduce the exempt fraction.

Land, co-owners and other limits

• Land of one-half hectare or less, including the area under the housing unit, is usually accepted as contributing to residential use. Larger areas generally are not, unless needed for use and enjoyment as a residence.
• Co-owners each report their own share and designate separately, and each can designate only if no other property is designated for their family unit that year.
• A co-owner who does not live in the home, such as an adult child on title for a parent, cannot designate it unless the unit was ordinarily inhabited in the year by that co-owner or their spouse or partner, former spouse or partner, or child.
• If you owned the property continuously since before 1982, section 40(6) limits the gain by treating it as reacquired at fair market value at the end of 1981.
• A gain on a flipped property, meaning a housing unit in Canada owned or held less than 365 consecutive days before it is sold, is deemed business income and the principal residence exemption does not apply. This applies to dispositions after 2022, and there are exceptions, such as a sale due to a death, the breakdown of a marriage or common-law partnership where the couple has been separated at least 90 days, a serious illness or an eligible relocation.
• If you forget to designate in the year of sale, you can ask CRA to amend that year's return. CRA may accept a late designation, but a penalty may apply, and under the Income Tax Act it is the lesser of $8,000 and $100 for each complete month between the due date and the date of the application.

What to do next

• List the years you owned each property and who used it.
• Record purchase prices, improvements and selling costs to work out the adjusted cost base.
• Check whether anyone else in your family unit has designated a property for the same years.
• Report the sale and designation on Schedule 3 and Form T2091(IND) in the year of sale.
• Ask a lawyer or accountant to compare designation options before you file.

Frequently asked questions