Principal Residence Exemption on Divorce or a Spouse's Death in Canada

A separation, a divorce or the death of a spouse often leaves one home at the centre of the financial picture. The family home is usually the largest asset, and the tax treatment of a later sale depends on how the home was designated over the years.

This article explains, in general terms, how the principal residence exemption works for separated, divorced and widowed owners. Every situation turns on its own facts, so use this as background for a conversation with a lawyer or accountant.

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

How a home is designated

A principal residence is a housing unit that you own, alone or jointly with someone else, and that you, a spouse or common-law partner, a former spouse or partner, or a child ordinarily inhabited in the year. Since the 2016 tax year, the sale of a principal residence must be reported on Schedule 3 of the T1 return, even if there is no gain or the whole gain is exempt.

Individuals designate the property and calculate any gain on Form T2091(IND). Only page 1 needs completing if the property was the principal residence for all years owned, or all years except one. CRA allows the exemption only if the disposition and designation are reported.

The family unit rule when you separate

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.

There is an exception for separated couples. A spouse or common-law partner who was separated for the whole year under a court order or written separation agreement is not in the same family unit for that year, so each can designate a different home. Without that court order or written agreement for the whole year, you should not assume the exception applies, so it is worth getting advice before you sign anything.

Older years follow different rules. For 1982 to 1992 the one-property rule applied only to spouses, so common-law partners could designate different homes, and before 1982 more than one home per family could be designated.

Splitting years and transfers between spouses

Spouses may split years between two homes by designating each home for different years, as long as no year is designated for two properties. This can matter if a couple owned a house and a cottage and later separate.

When one spouse or former spouse takes over the home by transfer, a spouse, former spouse, or qualifying spousal or alter ego trust that acquires the home is treated as having owned it for the period the transferor owned it, so the transferor's designated years can count. In general, years of ownership do not carry over to someone who simply inherits, except under the spousal rollover rules.

A former spouse who still lives in a home you own can matter too, because the home counts if a former spouse or partner ordinarily inhabited it in the year. Whether that helps depends on the facts and on what else is designated for your family unit.

When a spouse dies

A deceased person is considered to have sold all property just before death, and the designation applies only until the date of death. Even if the gain is fully exempt, the executor must designate the home on the final return using Schedule 3 and Form T1255.

If the home passes to a surviving spouse or common-law partner resident in Canada, or to 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.

When the rollover applies, the surviving spouse is treated as having owned the home for the period the deceased owned it, so the deceased's designated years can count.

What to do next

• List every property you and your spouse or partner have owned, with purchase and sale dates.
• Find any court order or written separation agreement and note its date.
• Work out which home was designated for which years, and make sure no year is used for two properties.
• Gather past returns, Schedule 3 copies and records of improvements.
• If an owner has died, tell the executor the home details before the final return is prepared.
• Speak with a lawyer or accountant before a transfer, buyout or sale, since timing can change the result.

If you forgot to designate in the year of sale, ask CRA to amend that year's return. CRA may accept a late designation in certain circumstances, but a penalty may apply.

Frequently asked questions