Plus-One Rule for the Principal Residence Exemption in Canada

You bought a home, lived in it for a while, and then something changed. Maybe you moved out and rented it, maybe you bought a second property, or maybe part of the time it sat vacant. Now you are selling, and you want to know whether the gain is fully tax-free or only partly.

The answer runs through a formula in the Income Tax Act, and one small feature of that formula, the "plus one" year, often decides the outcome. This article explains the formula in plain words, when the extra year helps, and what can reduce it.

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

How the exemption formula works

When you sell a home, the exempt portion of the gain is worked out under paragraph 40(2)(b) of the Income Tax Act using the formula A − (A × B/C) − D. You do not need to love algebra to follow it. The key is the fraction B/C, which compares the years you designate the home to the years you owned it.

The plus-one year is added to B, which is why a home that qualifies for all years owned except one can have its whole gain exempt. How the formula applies to your own numbers depends on your situation, so it is worth confirming with a lawyer or accountant. The smaller B is compared with C, the more of the gain is left exposed to tax. Half of a capital gain is taxable.

What the plus-one year does

The "plus one" sits inside B. If a home was your principal residence for all the years you owned it except one, the extra year in B means the whole gain is exempt. CRA explains this as letting you designate the sold home for the year of sale when you also bought another home that year.

The same idea appears in the folio: when one home is sold and another is bought in the same year, both are treated as principal residences for that year under the "one plus" rule. In practical terms, it smooths over the overlap that almost every move creates.

It does not rescue a long gap. If there are several years in which the home was not your principal residence, the extra year covers only one of them, and part of the gain will generally be taxable.

What can reduce or remove the extra year

• Non-residence: the plus-one year is not available if you were not a Canadian resident in the year you bought the new property, and where you were non-resident in the acquisition year, B counts only years of Canadian residence.
• Vacant land years: years in which the property was vacant land count in C but not in B, so they reduce the exempt fraction.
• The one-property rule: only one property per family unit can be designated as a principal residence for each year from 1982 onward.
• Pre-1982 ownership: if you have owned the property continuously since before 1982, the gain is limited by treating the property as sold and reacquired at fair market value at the end of 1981.

For 1993 and later years, your family unit is you, your spouse or common-law partner, and your unmarried children under 18. There are exceptions. 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. For 1982 to 1992 the one-property rule applied only to spouses, so common-law partners could designate different homes.

Years when nobody lived there

To be a principal residence for a year, the home must be ordinarily inhabited in that year by you, your spouse or common-law partner, a former spouse or partner, or your child. Whether that is true is a question of fact, and even a short period of occupation in the year can be enough, though a brief stay generally will not qualify if the main reason for owning is to earn income.

If no qualifying person lived there in a year, for example because you moved out and the home was rented or vacant, the property can still be treated as your principal residence for that year through a subsection 45(2) or 45(3) election. Those elections have their own rules and limits, so it is worth reading about them before you rely on them.

Spouses with two homes may also split years between them by designating each home for different years, as long as no year is designated for two properties.

Reporting the sale and what to do next

Since the 2016 tax year, the sale of a principal residence must be reported on Schedule 3 of your T1 return, even if there is no gain, and CRA allows the exemption only if the sale and designation are reported. Individuals designate the property and calculate any 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.

• List the year you bought the home, the year you sold it, and each year it was your principal residence.
• Note any year in which you or your family unit also designated another property.
• Note any years of non-residence in Canada or of vacant land.
• Gather the purchase and sale documents and records of improvements and selling costs.
• Report the sale on Schedule 3 and complete Form T2091(IND).
• Ask a lawyer or accountant to check the numbers if you have a gap of more than one year.

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 in certain circumstances, but a penalty may apply. The penalty is the lesser of $8,000 and $100 for each complete month between the due date and the date of the application.

Frequently asked questions