Principal‑Residence Designation: ‘Plus‑One’ Rule and Future Capital‑Gain Exposure

Overview

As many Canadians know, the Principal Residence Exemption (PRE) is one of the most significant tools available to shelter capital gains from tax. By designating your home as your "principal residence", you can avoid paying any capital gains tax on the sale. Given this incentive, many retirement and wealth building plans are built around the idea of selling a residence on a tax-free basis.

Designating a home as a principal residence is straightforward, and the CRA's forms and approved tax filing software will facilitate this process. For a general overview of how this works, including spousal and change-of-use considerations, please see the CRA's official page.

The principal residence exemption has a built-in "plus one" rule which is generally explained as a way to treat two properties as a principal residence in the same year (when selling an existing home and buying a new one in a single year).

However, specific considerations arise when applying the plus one rule in the context of overlapping property ownership. This article will explore the implications of the "plus one" rule and how it can affect future capital gains tax exposure.

Special Considerations for the "Plus One" Rule

The "plus one" rule does not technically allow two homes to simultaneously be designated as a principal residence. In fact, the Income Tax Act permits only one particular property to be designated as a principal residence in any given tax year (s.54 para (c) of "principal residence" definition). Instead, the "plus one" rule adds a "free" year to the number of years a property is designated a principal residence when calculating a taxpayer's (potential) capital gain upon selling their residence (outlined in this income tax folio). Therefore, the "plus one" rule has the effect of allowing two properties to be capital gains exempt in the same year, but still, only one property can be designated as a principal residence in any given tax year.

Different results can arise depending on how a taxpayer decides to designate their principal residence each year.

For example, say you purchased your first house (house #1) in 2018 and sold it in 2023. Also in 2023, you purchased a new house (house #2). When doing your 2023 tax return, which house do you designate as your principal residence? Does it matter? See below for an illustration up to this point.

In 2023, when filing your Form T2091IND you must indicate the number of years you owned the property (line 7 of Section 2) and you also must indicate the total number of years you are designating the property as your principal residence (Section 1). In this example, you have owned your first house for 6 tax years, and may be inclined to designate it as your PR for 6 years as well. However, you could also designate it for 5 years total (so 2018 to 2022) and then rely on the "plus one" rule to account for 2023. Would this have different implications?

Scenario A – Not Utilizing +1 on House #1

We can continue the example forward to analyze the implications of this decision. A few years later, in 2026 you purchase a new house (house #3) before selling house #2. The house #3 purchase closes on December 1st 2026, but you are not able to sell house #2 until January 15th, 2027 due to market conditions.

As a result, (i) since you designated house #1 as your principal residence in 2023 (and by extension house #2 could not be a PR in 2023), and (ii) since you sold house #2 in 2027, house #3 will not be eligible for designation as a principal residence in either 2026 or 2027, meaning you will owe some capital gains tax when house #3 is eventually sold (given that the plus one rule only covers one year of non-PR status).

However, had you simply designated house #1 differently (not as your PR in 2023), you could have avoided this possible future tax liability (and still without incurring capital gains tax on house #1). See below a revised version of event with this change.

Scenario B – Utilizing +1 on House #1

In this alternate scenario, house #3 would be able to be designated as a principal residence in 2027, meaning it would not necessarily be subject to capital gains tax when sold (as 2026, which is not a PR year, could be accounted for by the "plus one" rule).

Summary

Overall, allocating principal residence designations can have tax implications in certain scenarios. Since the designation made on the original home can affect how future properties are taxed, it is important to consider how that initial designation is applied.

In particular, taxpayers who may have overlapping property ownership (such as a secondary or recreational property, multiple tax years between a purchase and sale, or separate residences owned by spouses) should be thoughtful in their application of the "plus one" rule.

Last reviewed – April 14 2025

Disclaimer: This content is for informational purposes only. Consult a qualified professional for advice specific to your financial circumstances.