Principal Residence Exemption When the Owner Dies in Canada

When someone dies owning a home, the tax question often comes as a surprise to the family. The house may not be sold for months, yet the Canada Revenue Agency (CRA) treats the death as a sale for tax purposes. For many families the principal residence exemption wipes out the tax on that deemed sale, but only if the executor takes the right steps.

This article explains, in general terms, how the exemption works on a final return, what the executor has to report, and where the spousal rollover fits in. Every estate is different, so confirm the details with an accountant or lawyer.

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

Why death creates a deemed sale

A deceased person is considered to have sold all of their property just before death. This is called a deemed disposition. It applies whether or not the home is actually sold, and it can produce a capital gain on the final return.

The capital gain is the proceeds of disposition minus the adjusted cost base and any outlays and expenses of the sale, and half of the capital gain is taxable. How the value of the home is established for the final return depends on the estate, so it is worth confirming with an accountant or lawyer.

The principal residence designation applies only up to the date of death.

How the executor designates the home

Even if the gain is fully exempt, the executor must designate the home on the final return using Schedule 3 and Form T1255. Since the 2016 tax year, a sale or deemed sale of a principal residence must be reported on Schedule 3, even if there is no gain, and CRA allows the exemption only if the disposition and designation are reported.

• Report the deemed sale in Part 2 of Schedule 3.
• Make the designation in Part 1 by ticking box 1 at line 17900 if the home was the principal residence for all years owned or all but one, or box 3 if it was not the residence for every year owned.
• Individuals calculate the gain on Form T2091(IND), and only page 1 needs completing if the home was the principal residence for all years owned, or all years except one.
• Include the Form T1255 designation with the final return.

Line numbers can change from year to year, so check the current form for the year of death.

When the spousal rollover applies

If the home passes to a surviving spouse or common-law partner who is 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 of the rollover, in which case the proceeds are treated as equal to fair market value immediately before death. The election is made on the final return, property by property. Electing out can make sense when the home is fully exempt, but whether it does depends on the whole estate, so get advice before choosing.

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.

What can reduce or limit the exemption

The exemption is not automatic. Several rules can affect how much of the gain is sheltered.

Also remember that a home is personal-use property, so a loss on its sale cannot be claimed.

What to do next

Final returns involve deadlines and choices that are hard to reverse, so organize the facts early. If the designation is missed, CRA may accept a late designation in certain circumstances, but a penalty may apply. The late-election penalty 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.

• Confirm the date of death and who now has the right to possess the home.
• Gather the purchase documents, records of additions and improvements, and any evidence of the home's value around the date of death. The adjusted cost base generally includes purchase costs and capital improvements, but not ordinary repairs.
• List every property the deceased and their family unit owned, and note which years each was lived in.
• Check whether the home was ever rented, used for business, or partly used to earn income.
• Find out whether the home passes to a spouse or common-law partner and whether the rollover applies.
• Ask an accountant or lawyer to prepare Schedule 3 and Form T1255 with the final return.

Frequently asked questions