Selling a Home You Once Rented Out: How the Tax Actually Works
Key takeaways
- Selling your home is usually tax free, but you still have to report it on Schedule 3 and Form T2091.
- Turning a home into a rental triggers a deemed disposition at fair market value, with no money changing hands.
- The section 45(2) election can defer that, and can add up to four years of exemption while you are not living there.
- Claiming CCA disqualifies the exemption for those years, and is recaptured on sale. It is rarely worth it on a home you may sell.
- The capital gains inclusion rate remains 50%. The proposed increase to two thirds was deferred and then cancelled.
The rules for selling a home you have lived in are simple. The rules for selling a home you lived in and then rented, or rented and then lived in, are not. The difference between the two is usually a single election, filed on time, that most people have never heard of.
The starting point: the principal residence exemption
A gain on your principal residence is generally exempt for every year the property qualified. A family unit can designate one property per year, which matters for anyone with a cottage as well as a house.
The exemption is not automatic on paper. Since 2016 the sale must be reported even when the whole gain is sheltered. Skipping the reporting is how a tax-free sale turns into a penalty.
What happens the day the use changes
When you convert your home to a rental, tax law treats it as though you sold it at fair market value that day and bought it back at the same price. Nothing moves in the bank. The disposition is deemed.
The gain up to that day is normally covered by the exemption. Everything after that day is an ordinary capital gain, because the property is now an investment.
This is why the value on the day the use changes matters so much. Get an appraisal or a documented market opinion at the time, not years later when you sell and are trying to reconstruct it. A defensible number on the day is worth more than an argument afterwards.
The election that changes the answer
Section 45(2): home becoming a rental
You can elect that the change of use did not occur. The deemed disposition is deferred, and the property can be designated as your principal residence for up to four additional years even though you are not living in it.
The election is a signed letter filed with your return for the year the use changed. Miss the year, and the conversation becomes a request for relief rather than a filing.
Section 45(3): rental becoming a home
Moving the other way, from an income-producing property into your own home, there is a corresponding election that defers the deemed disposition until you actually sell.
The capital cost allowance trap
Claiming CCA on a rental property feels like free money. On a property that was, or may become, your home it is usually the opposite.
- A property does not qualify as a principal residence for any year CCA was claimed on it.
- CCA claimed over the years is recaptured as ordinary income when you sell, taxed at full rates rather than capital gains rates.
- The section 45(2) election does not rescue the years in which CCA was claimed.
A few hundred dollars of annual deduction can cost several thousand in exemption. It is one of the clearest cases in Canadian tax where the obvious deduction is the wrong move.
How the exemption is prorated
Where a property was your home for part of the ownership period and a rental for the rest, the sheltered share of the gain is roughly:
| Element | What it means |
|---|---|
| Years designated, plus one | The extra year covers a move where you own two homes briefly |
| Divided by years owned | The full period of ownership, in years |
| Applied to the gain | The remainder is a normal capital gain at the 50% inclusion rate |
Own a property for ten years, live in it for six, rent it for four, and roughly seven tenths of the gain is sheltered. The remaining share is a capital gain, half of which is taxable.
Renting out part of the home you live in
Renting a basement suite while living upstairs does not automatically cost you the exemption. CRA’s administrative position generally preserves it where the rental use is ancillary to the main use, there is no structural change to the property, and no CCA is claimed.
Change any one of those three and the analysis changes.
Frequently asked questions
Do I pay capital gains tax when I sell my home in Canada?
Usually not. The principal residence exemption can shelter the entire gain for the years the property qualified. But the exemption is not automatic in the paperwork sense: you must still report the sale on Schedule 3 and file Form T2091, even when no tax is owing. Failing to report can cost you a penalty on a sale that was tax free to begin with.
What happens when I turn my home into a rental?
The change of use is treated as a deemed disposition. You are considered to have sold the property at fair market value on the day the use changed, and to have immediately reacquired it at that value, even though no money moved. Any gain to that date is generally sheltered by the principal residence exemption. Growth after that date is a normal capital gain.
What is the section 45(2) election?
It lets you elect that the change of use did not happen, deferring the deemed disposition. It also allows the property to be treated as your principal residence for up to four more years while you are not living in it. It is made by a signed letter filed with the return for the year the use changed.
Does claiming CCA on a rental affect the exemption?
Yes, and this is the trap. A property does not qualify as a principal residence for any year in which capital cost allowance was claimed on it. The annual depreciation deduction can quietly cost far more than it saved, and CCA is also recaptured as income on sale.
How is the exemption calculated if the property was a rental for part of the time?
The sheltered portion is roughly one plus the number of years designated as your principal residence, divided by the number of years you owned it, applied to the gain. The extra year in the formula exists so that someone moving between two homes in the same year is not penalised. Only one property per family unit can be designated for any given year.
Related reading: Canadian tax deadlines and when the sale must be reported, the current tax brackets that apply to the taxable half of a capital gain, and the lifetime capital gains exemption where a business rather than a home is being sold.
Want a second opinion before you file?
If you are about to convert a property, or you are selling one that changed use somewhere along the way, the election deadlines and the value on the day are the two things worth getting right in advance.
We work with owner-managed businesses and property owners across British Columbia, Alberta, Manitoba, Saskatchewan and Ontario, from offices in Abbotsford, Langley and Brampton. Talk to us.