Selling a Rental Property in Ontario: Legal and Tax Steps

Selling a rental property involves more moving parts than selling a home you live in. There are tenants whose rights continue, a mortgage that may carry a prepayment penalty, and tax rules that can produce income as well as a capital gain.

This article walks through the main legal and tax issues in plain terms so you can plan before you list. Because the rules depend on your lease, your mortgage and your tax history, treat this as a map and confirm the details with a lawyer and accountant.

Tax on the sale of a rental property

In the year you sell, you may need to add a recapture amount to income (T776 line 9947) or deduct a terminal loss (line 9948). Recapture arises when the sale proceeds exceed the class's opening UCC plus additions. A terminal loss arises when no property remains in the class but an undeducted UCC balance does.

A property sold at a gain can produce both a capital gain and a recapture. Legal fees on the sale reduce proceeds for both calculations. UCC stands for undepreciated capital cost, which is the tax record of what you have not yet deducted on the building.

A change in use, for example a home becoming a rental, is generally treated as a sale at fair market value followed by immediate reacquisition. If part of a home was used to earn income, proceeds and cost are split between the personal part and the income-producing part. Your accountant can work out how much of your gain is taxable.

Your tenants and the sale

If your buyer wants the property empty because they or a close family member will move in, a specific process applies. The purchaser's own-use N12 is available only where the residential complex has no more than 3 units and the landlord has entered an agreement of purchase and sale. The notice period and any compensation owed depend on when the notice is given and on the current rules, so confirm them with a lawyer before serving an N12.

A landlord cannot personally remove a tenant or change the locks. Only the Court Enforcement Office (Sheriff) can enforce an LTB eviction order. Illegal lockouts can bring fines of up to $100,000 for an individual or $500,000 for a corporation. Our separate article on selling with tenants and vacant possession covers the N12 steps in more detail.

If your buyer is an investor who will keep the tenants, the usual approach is to sell with the tenancy in place. The agreement of purchase and sale should say so clearly, and your lawyer can review how lease details are handled.

Your mortgage on a rental

Paying off a mortgage before the term ends can cost money. A prepayment penalty is usually the higher of three months' interest on the balance owed and the interest rate differential (IRD). Lenders typically use the IRD when your current rate is above the current market rate and the contract was signed less than five years ago. An administration fee may also apply.

For an example, on a $200,000 balance at 6% with 36 months left, the IRD was $12,000 against $3,000 in three months' interest, so the penalty was $12,000. The cost depends on the amount prepaid, the months left in the term, interest rates and the lender's own method, and banks often publish penalty calculators.

• Prepayments within the lender's prepayment privileges generally carry no penalty, but privileges vary and unused amounts usually do not carry over.
• Open mortgages allow prepayment without penalty.
• Porting moves your existing rate and terms to a new property, so you do not break the contract.
• Transferring a mortgage to another lender before the term ends can trigger a penalty.

For a mortgage not due for more than five years from its date, the borrower may pay it off after the five years by paying principal and interest to the payment date plus three months' further interest in lieu of notice. There are exclusions, including mortgages given by corporations. If you hold the property through a company, ask your lawyer how this applies.

Closing: discharge and other loose ends

For an electronic discharge of a lender's mortgage, the Law Society of Ontario advises lawyers to ask the institutional lender early whether the lender or the lawyer will prepare and register it. If the lender will register it, the lawyer should get that confirmation in writing. Closing duties include delivering the discharge funds to the lender in a timely manner and getting registration particulars to the buyer's lawyer.

The Law Society's position is that, absent an express term in the agreement of purchase and sale, lawyers should not give or accept personal undertakings to obtain and register discharges of private mortgages after closing. If you have a private mortgage, raise this with your lawyer early.

Other items can affect a rental sale. Since June 6, 2024, a Notice of Security Interest cannot be registered on title for consumer goods, and existing consumer-goods notices were deemed expired that day. If you have a rented water heater or similar equipment, read the contract, since consumer guidance says to ask who is responsible for transferring the contract on a sale or paying cancellation fees. If the property has a septic system, a buyer takes on all obligations associated with it, and the province advises buyers to request approvals, operation and maintenance records and past inspection reports.

What to do next

• Gather the leases, tenant contact details and any notices already given.
• Ask your lender for the payout amount and penalty calculation, and ask who will register the discharge.
• Pull your depreciation (CCA) records and the T776 figures from past returns for your accountant.
• Collect records for any water heater, solar or similar equipment contracts.
• If there is a septic system, locate its permits, maintenance records and inspection reports.
• Speak with a real estate lawyer before you sign an agreement of purchase and sale, so tenancy and closing terms are clear.

Frequently asked questions