Home or cottage: Which should be a principal residence?

By Curtis Davis | May 11, 2021 | Last updated on May 11, 2021
3 min read
house versus cottage
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This article appears in the June 2021 issue of Advisor’s Edge magazine. Subscribe to the print edition, read the digital edition or read the articles online.

For clients with a couple of properties, selling one or both means they have a tough tax decision to make. Only one principal residence per year can be exempt from capital gains tax, so which home should it be?

For tax purposes, a principal residence is a property owned and “ordinarily inhabited” by the client and/or spouse (including common-law partners). (The property can also be owned by an eligible trust.) “Ordinarily inhabit” generally means the property’s main use isn’t to produce income. The property is designated as a principal residence on the tax return for the year it’s sold.

The principal residence exemption (PRE) can exempt up to 100% of the capital gain on the sale, using the following formula:

Home or cottage: Which should be a principal residence? equation

The capital gain is the home’s value at disposition less its adjusted cost base (post-1981 acquisition price and costs + capital improvements).

The “1 +” is available only to Canadian residents and allows for two principal residences to be eligible for the PRE in the year one is sold and a new one is subsequently purchased.

Dividing by the total number of years the property was owned allows for the possibility of a partial PRE when two or more properties are owned concurrently.

As of 1982, only one property can be designated as a principal residence per year per family unit (which includes a spouse or common-law partner and minor children).

Case study

Parvin and Preeti sold their city house and are retiring to their cottage. The city house has a substantial profit, and they wonder if they should use the PRE to shelter the gain or save the PRE for the cottage. Here is a breakdown of the two properties:

City house


Acquisition date 1986 Acquisition date 1995
ACB $100,000 ACB $60,000
Disposition year 2021 Fair market value in 2021 $700,000
Disposition proceeds $940,000
Years owned 36 Years owned 27
Capital gain $840,000 Capital gain $640,000

From 1986 until the end of 1994, Parvin and Preeti owned only the city house. Since the house was their only residence for those years, they can protect part of the gain on the house without impacting the PRE for the cottage. For the overlapping years, they must decide which property to designate as their principal residence.

At first blush, it may appear that the PRE should be used to shelter the gain on the city house, because its total capital gain is higher ($840,000 versus $640,000). However, Parvin and Preeti need to calculate the average capital gain to see where the PRE will offer the most tax savings.

This is where it gets interesting. The average capital gain for the city house is $23,333 ($840,000 / 36); for the cottage, it’s $23,704 ($640,000 / 27). As a result, for the years of concurrent ownership, applying the PRE to the cottage would generate the highest tax savings.

Food for thought

With their advisor, Parvin and Preeti take stock of their situation and consider the following:

RRSP contributions. If they have unused RRSP contribution room, they could use an RRSP contribution to defer tax on some of the gain on their city house while saving part of the PRE for the cottage. Since only half the capital gain is taxable, their total contribution room needs to be only half the total gain not covered by the PRE. Remember, if they sell the cottage after Dec. 31 of the year they turn 71, they’ll no longer be able to contribute to an RRSP.

Charitable donations. They can donate an amount that would create a tax credit large enough to offset the gain’s associated taxes.

Life insurance. If they chose to use the PRE for the city house, insurance could provide funds to cover the anticipated tax liability on the cottage. The tax liability is half the total unprotected capital gain multiplied by their marginal tax rate. A joint last-to-die policy would pay out when the second spouse dies and the tax liability comes due.


When selling one or more eligible properties, allocating the PRE can be challenging. Crunch the numbers to understand where the PRE will provide the greatest tax savings, and then consider your client’s entire financial picture to see if other deductions and credits can reduce taxes.

Curtis Davis, FCSI, RRC, CFP, senior consultant for tax, retirement and estate planning services, retail markets at Manulife Investment Management

Curtis Davis headshot

Curtis Davis

Curtis Davis, FCSI, CFP, TEP, is director for tax, retirement and estate planning services, retail markets at Manulife Investment Management.