Principal Residence Exemption on a Deceased Person's Home in Canada

If you are an executor, you may be dealing with a home that was lived in for decades. The tax questions come in two stages: what happens on the final return of the person who died, and what happens when the estate or an heir later sells.

This article walks through both stages in plain terms. It is general information only, and the right answer for a particular estate depends on the facts, the will and the dates involved.

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

Stage one: the final return

A deceased person is considered to have sold all property just before death. The principal residence designation applies only until the date of death.

Even if the home is fully exempt, the executor must designate it on the final return using Schedule 3 and Form T1255. Schedule 3 is where the sale is reported, and the designation is made in Part 1. The deceased's own years of ownership and use are what count at this stage.

If the home goes to a spouse

If the home passes to a surviving spouse or common-law partner resident in Canada, or a qualifying testamentary spousal trust, and it vests within 36 months of death, the rollover applies and no deemed disposition arises. The legal representative can elect out, in which case proceeds equal fair market value immediately before death. The election is made on the final return, property by property.

A spouse, former spouse, or qualifying spousal or alter ego trust that acquires the home by transfer is treated as having owned it for the period the transferor owned it, so the transferor's designated years can count. Whether to elect out of the rollover is a real choice with consequences for later years, so it is worth discussing with an accountant.

Stage two: the estate or heir sells later

For an heir, ownership is acquired on the date the person obtains a right to possess the property for their enjoyment. Years of ownership for the heir start from that date, and the deceased's years do not carry over except under the spousal rollover rules.

The capital gain is proceeds of disposition minus adjusted cost base and the outlays and expenses of the sale, and half of the capital gain is taxable. A home is personal-use property, so a loss on sale cannot be claimed.

A home can be a principal residence only if a qualifying person ordinarily inhabited it in the year, meaning the owner, a spouse or common-law partner, a former spouse or partner, or a child. If no qualifying person ordinarily inhabits the home in a year, for example because it is vacant, the property can still be treated as the principal residence for that year through a subsection 45(2) or 45(3) election, and that turns on the facts. These elections are not available if capital cost allowance was claimed on the property after 1984 and on or before the change in use. A personal trust can claim the exemption only if it meets the section 54 conditions, and after 2016 it must be an alter ego, spousal or common-law partner, joint spousal, or qualified disability trust, or a trust for a qualifying minor or disabled beneficiary. For a trust that no longer qualifies after 2016, there is protection for gain accrued to the end of 2016 on its first disposition of the property after 2016. How this applies to a particular estate depends on the facts, so it is worth confirming with a lawyer or accountant.

Points that catch executors out

• Listing the home as a sale on the final return even when no tax is owing, because the designation must still be made.
• Forgetting that the 36-month window applies to the rollover.
• Assuming a co-owner who did not live in the home can designate it. A co-owner such as an adult child on title cannot designate it unless that co-owner or their spouse, former spouse or child ordinarily inhabited it in the year.
• Selling quickly. A flipped property, one owned less than 365 consecutive days before disposition, produces deemed business income and the exemption does not apply. The rule does not apply to a disposition that can reasonably be considered to occur due to, or in anticipation of, the death of the taxpayer or a related person.
• Missing the designation entirely. CRA may accept a late designation in certain circumstances, but a penalty may apply.

If a late designation is accepted, the penalty under the Income Tax Act is the lesser of $8,000 and $100 multiplied by the number of complete months between the due date and the date of the application. The Minister may waive or cancel penalties or interest if the request is made within ten calendar years after the tax year ends.

What to do next

• Confirm the date of death, who now holds or will receive the home, and when they obtain the right to possess it.
• Collect the purchase documents, renovation receipts and any past Schedule 3 forms.
• Get a fair market value as of the date of death for the file.
• Decide with your accountant whether any rollover election is wanted.
• Prepare Schedule 3 and Form T1255 with the final return.
• Keep records of selling costs if the estate or an heir sells later.

Frequently asked questions