Income Tax Act s. 40(2)(b)
Principal Residence Exemption
When a principal residence is sold, the gain is not taxable if it has been the person's principal residence for the whole time it has been owned. This is because the principal residence exemption eliminates the capital gain. In this case, there is no need to report the sale on your tax return.
A taxpayer and spouse may only designate one principal residence between them for each tax year after 1981. For years prior to 1982, each individual taxpayer can designate one principal residence, so if a couple has owned both a primary home and a cottage for decades, the principal residence exemption is available for both homes for the years prior to 1982.
If a home has been owned since before 1972, only the increase in value since December 31, 1971 is used to calculate the gain before deducting the principal residence exemption.
Canada Revenue Agency (CRA) usually considers that if there is more than 1/2 hectare (1.25 acres) of property, only 1/2 hectare of the land can be considered part of the principal residence, and there would be a capital gain on the excess when the property is sold, even if the rest is the principal residence. However, they also consider whether the property is subdividable. Thus, if the property is 2 hectares, and is not subdividable, they may consider the whole amount of the land to be part of the principal residence.
If your home was not your principal residence for the whole time that you owned it, you will have to report the sale on your tax return, and calculate the principal residence exemption to deduct from your capital gain.
The principal residence exemption calculation is:
(# of years home is principal residence + 1) x capital gain
# of years home is owned
The extra year in the top of the equation means that when a person moves, both the old home and the new home will be treated as a principal residence in the year of the move, even though only one of them can actually be designated as such for that year.
