Principal Residence of the Deceased: Tax Treatment at Death in Canada

For most families the home is the largest asset in the estate. Executors often ask whether the house triggers a tax bill on the final return, and the answer is often no, but only if the paperwork is done properly.

This article walks through how the deemed sale applies to a home, how the principal residence exemption works, and the situations where part of the gain can still be taxable.

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

The home is treated as sold at death

The CRA says the deceased is treated as having sold all property just before death, which can create a gain or loss. The gain is the fair market value on the date of death minus the adjusted cost base. For a home, that means the value at death compared with what the person paid plus qualifying costs.

The tax on that gain is reported by the deceased on the final return, not by the beneficiaries. The person who inherits the house takes it at its fair market value at death as their cost.

How the principal residence exemption applies

A gain on the deceased's home may be fully or partly exempt. The property must still be reported on Schedule 3 and designated on Form T1255, and the designation covers only years up to the date of death.

The CRA says the gain is fully exempt if the home was the principal residence for all the years it was owned, or all but one, and neither the owner nor a family member designated any other property as a principal residence for those years.

The formula in section 40(2)(b) of the Income Tax Act is the gain, minus the gain multiplied by the years designated over the years of ownership, minus any other adjustment. The years designated include a one-year adjustment in some cases, and the years of ownership are counted after acquisition. That is why the exemption is complete only when the home qualifies in all years or all but one, and why the exact wording is worth confirming with a professional.

When part of the gain can still be taxable

• The home was not the principal residence for every year owned, for example it was rented out or the owner lived elsewhere for part of the time.
• A family member or the deceased designated another property, such as a cottage, for some of the same years. A second property cannot be designated for a year in which another property of the family unit is designated.
• Only one property can be designated for each year, so part of the deemed gain on the other property may be taxable on the final return.

If there is more than one property, the designation choices affect each other. The best allocation depends on the values, the years owned and each property's cost, so it is worth running the numbers before filing.

Exceptions that change the result

If the home rolls over to a spouse, the gain is deferred rather than erased. The question of the exemption can then come up again when the spouse later sells or dies.

What to do next

• Confirm the date of death and get a supportable value for the home as of that date
• Collect the purchase records and receipts for major improvements to support the adjusted cost base
• List every property the deceased or the family unit owned in each year, including cottages
• Decide whether the home goes to a spouse and whether to elect out of the rollover
• Report the home on Schedule 3 and complete Form T1255 for the years up to death
• Have an accountant or lawyer review the designation if more than one property is involved

If the estate sells the house after death, the gain on that later sale is reported on the estate's T3 return, not on the final return. Keep that separate from the deemed sale at death.

Frequently asked questions