Leaving Canada but Keeping the House: What Happens to Your Principal Residence Exemption When You Sell Later

Empty, rented, or still home to your spouse or kids: the three things a house can do after its owner moves abroad, and the one residency test in the Income Tax Act that applies to all of them.

I’m Arthur Zhao, a Toronto real estate broker. Think about the house keys on the kitchen counter the night before a move overseas. There are really only three places they can go: into a drawer, because the house will sit empty; into an envelope for a tenant or property manager; or into the hand of a spouse or child who is staying behind in Canada.

Each choice feels like it should lead to a different tax answer on the day the house is finally sold. Under the Income Tax Act, they do differ on some things: whether a year can be designated as your principal residence, whether a change-in-use rule kicks in, whether a four-year limit applies. But they all run into the same test in s.40(2)(b), and that test is about where you live, not who is sleeping in the house. Below I go through each set of keys in turn, after one starting point they all share.

The shared starting point: what leaving Canada does (and doesn’t do) to the house

When an individual stops being resident in Canada, s.128.1(4)(b) treats them as having sold almost everything they own at fair market value just before leaving. The list of exceptions starts with “real or immovable property situated in Canada” in s.128.1(4)(b)(i). So the departure itself does not trigger a deemed sale of a house in Toronto or Markham; the house is not revalued on the way out under this paragraph.

There is one optional door. Under s.128.1(4)(d), an individual can elect, in prescribed form and manner, to treat property described in (b)(i) or (ii) as disposed of and reacquired at fair market value at departure. The same paragraph then limits how the resulting income and losses are counted. It is a technical election with knock-on effects, and whether it fits a particular situation is a question for a tax professional, not for a blog post.

What follows applies in each of the three scenarios: the exemption is worked out later, at the actual sale, using the fraction in s.40(2)(b). A year is counted in the bottom of that fraction (C) if you owned the home in it, whether you lived in Canada or not. A year is counted in the top (B) only if the home was your principal residence for it “and during which the taxpayer was resident in Canada.” The year you actually leave is a special case; how it is counted for B is something to confirm with your tax advisor, and I am not drawing a conclusion on it here.

Keys in the drawer: the house sits empty

For an individual, the s.54 definition of principal residence requires that the housing unit be “ordinarily inhabited in the year” by you, your spouse or common-law partner, a former spouse or partner, or your child (paragraph (a)), or that you have made a s.45(2) or s.45(3) election (paragraph (b)), and in either case that you designate it for the year (paragraph (c)). The Act doesn’t give “ordinarily inhabited” its own definition, and a house nobody lives in raises an obvious question under paragraph (a).

Nothing in an empty house starts earning income, so the change-in-use rule in s.45(1)(a)(i) has nothing to act on, and there is no s.45(2) election to make.

Here is the part that is easy to miss: for the years after you’ve left, the “ordinarily inhabited” question doesn’t change the outcome in the formula. Even if a year somehow qualified, B counts it only if you were resident in Canada during it. Each empty year adds to C and nothing to B. That follows from reading s.40(2)(b) together with s.54; it’s my reading of the text, not a CRA ruling.

Keys to a tenant: the house becomes a rental

Renting the house out is a change in use. Under s.45(1)(a)(i), when property acquired for another purpose starts being used to earn income, you are deemed to have sold it at fair market value at that moment and bought it back at the same value.

Section 45(2) lets you elect, in your tax return for that year, to be treated as not having started using the property to earn income, so no deemed sale happens. You can rescind the election in a later year’s return, at which point the change in use is deemed to happen on the first day of that later year.

The election also feeds the principal residence definition: paragraph (b) of s.54 lets a property be a principal residence for years covered by a s.45(2) election. But paragraph (d) caps that. If a property would be a principal residence solely because of paragraph (b), it stops qualifying once it has had that status for 4 preceding taxation years. Section 54.1 relaxes the cap for years away because your or your spouse’s workplace was moved by an employer you aren’t related to, but only if you move back into the home while still in that job (or by the end of the year after it ends), or die during it, and the home is at least 40 km farther from the new workplace than where you lived instead.

Now put that next to the formula. The 4-year cap is about whether a year can be designated. Even a year that is validly designated through s.45(2) only enters B if you were resident in Canada during it. When the renting starts because you’ve left, the designated rental years and the non-resident years can turn out to be the same years. That is an inference from reading s.40(2)(b) and s.54 together, not something either section says in one sentence.

Keys to family: a spouse or child stays in the house

This is the scenario where paragraph (a) of s.54 most clearly fits. The test is that the unit is ordinarily inhabited by the taxpayer or by the taxpayer’s spouse or common-law partner, former spouse or partner, or child. If your spouse or child keeps living there, the house can qualify under (a) without relying on an election. Because the 4-year cap in paragraph (d) only applies when a property qualifies solely because of paragraph (b), it doesn’t come into play on this route (again, my reading of how (a), (b) and (d) interact).

Two other things still apply. First, paragraph (c) allows only one designated home per family unit per year: no other property can be designated for that year by you, a spouse or partner you weren’t separated from throughout the year, or a child under 18 who is not married or in a common-law partnership. Second, the residency test in B is about the taxpayer doing the calculation. Your spouse’s or child’s residency doesn’t change yours. If you were non-resident in a year, that year still goes into C and not into B, even with family living in the house the whole time.

If the spouse who stays is also on title, my reading is that the gain on each owner’s share is a separate calculation. How that plays out between two owners with different residency is worth confirming with a tax professional before listing.

The three routes side by side

The bottom two rows are identical across the three columns. That’s the point of the table.

A hypothetical to see the dilution

The numbers below are invented for illustration only. They are not anyone’s real file and not a tax calculation for your situation.

Suppose a homeowner sells years after moving abroad, and the gain on the house (A in the formula) is $300,000. Suppose the years owned after the acquisition date add up to 12 for C, and the resident years that qualify, plus the “one” the formula adds when you were resident in the year of purchase, add up to 8 for B. The exempt portion is $300,000 × 8/12 = $200,000. Assuming D is nil (D only matters for homes acquired before February 23, 1994 where a 1994 capital gains election was made), the gain left after the exemption is $100,000.

Under this hypothetical, it makes no difference whether the house was empty, rented, or occupied by family during the non-resident years. Those years are in the 12 and not in the 8 under all three routes.

When the sale actually happens

If you are a non-resident when the house is sold, the sale also involves the section 116 clearance certificate process and buyer withholding. That is a separate set of rules, and we cover it in a separate article. Bring your accountant in before you sign a listing agreement, not after an offer comes in, so the residency history and any elections are documented before closing.