Can I Claim Principal Residence Exemption With a Rental Suite?

You can claim the principal residence exemption with a rental suite, but only the portion you occupy escapes tax if the suite is structurally self-contained—meaning separate entrance, kitchen, bathroom—or if you’ve claimed capital cost allowance, which permanently taints the entire property’s eligibility. Informal arrangements like renting a spare bedroom with shared facilities typically preserve the full exemption because CRA treats them as ancillary, not a change in use. The distinction between a legal basement apartment and a roommate situation determines whether you face a deemed disposition, proportional gain calculation, and years of documentation headaches that most homeowners discover only when an auditor asks for appraisals dated to the conversion, not your panicked retrofit afterward, so understanding the mechanical triggers now saves you from expensive surprises later when the stakes involve tens of thousands in taxable gains you assumed were shielded.

Can you claim the principal residence exemption when you have a rental suite? The short answer

Can you still claim the principal residence exemption when you’re renting out a basement apartment or second suite in your Ontario home? Yes, but only if you structure it correctly and avoid triggering CRA’s change in use rules.

The exemption remains intact when your rental activity is genuinely ancillary to your primary residential use, meaning the suite functions as a secondary feature rather than transforming your property into an income-generating asset.

Here’s what keeps you safe:

The rental space stays well below 40% of your total floor area
You make zero structural changes to accommodate tenants
You never claim Capital Cost Allowance on the rental portion
The suite lacks complete self-contained status (separate entrance, kitchen, bathroom)
Your property remains primarily your home, not primarily your business

Cross these thresholds, and you’re facing partial or complete loss of exemption eligibility.

Converting your residence to income use triggers a deemed disposition where CRA calculates proceeds based on the property’s fair market value proportionate to the converted part. Understanding your down payment and closing costs upfront helps you track your adjusted cost base accurately for future capital gains calculations. You can file an election to avoid this deemed disposition, but doing so means you cannot claim CCA on your rental income.

PRE basics for a single‑family home in Canada before adding a suite

Before you even think about installing a basement suite or renting out part of your home, you need to understand how the principal residence exemption actually works when your property functions exclusively as your residence—no tenants, no rental income, no complications.

Understanding the principal residence exemption in its purest form—before rental complications arise—is essential for homeowners considering basement suites.

When you own a single-family home that you occupy entirely, the PRE structure is straightforward:

You own the property (alone or jointly)
You ordinarily inhabit it during the year
You don’t claim capital cost allowance
You make the designation when you sell
You pay zero capital gains tax if it was your principal residence for every year of ownership

No rental suite means no proportional calculations, no change-of-use considerations, and no designation headaches—the entire property qualifies, period.

For any year you claim the principal residence exemption, only one property per family unit can be designated, which includes your spouse or common-law partner and unmarried children under 18.

If you’re financing your home purchase or considering refinancing before adding a rental suite, ensure you work with a licensed mortgage broker who understands FSRA requirements in Ontario.

How a rental suite changes your PRE (space, time, and intention tests)

The moment you introduce a rental suite into your home—whether you’re finishing that basement apartment, converting the upper floor, or carving out a separate unit with its own entrance—you’ve fundamentally altered how the CRA evaluates your principal residence exemption, and the analysis now hinges on three distinct tests that determine whether you keep full PRE protection, lose it proportionally, or trigger a permanent taint that follows the property forever.

Test	What CRA Examines
Space	Self-contained kitchen, bathroom, separate entrance = distinct housing unit
Intention	Structural modifications signaling conversion purpose (kitchen additions, bathroom installations)
Time	When conversion occurred relative to occupancy period; claiming CCA depreciation

The rental suite creates immediate classification consequences: self-contained units split your property into multiple housing units, only one qualifies for principal residence exemption designation annually, and structural modifications document your intentional change of use. If the rental space remains part of your residence and you don’t earn income from it in the year of sale, the business or rental use does not impact gain calculations for exemption purposes. Allocation of gain between personal and rental portions becomes necessary when the space functioned as a distinct unit during your ownership period. For new home buyers navigating similar complexities with warranty coverage, understanding the structural modifications and their documentation becomes critical for both tax and property protection purposes.

Example scenarios: legal suite, informal rental, and family living rent‑free in the suite

Understanding these three tests means nothing if you can’t apply them to your actual situation, and most homeowners fall into one of three categories: those who’ve created a legal suite complete with its own kitchen and entrance, those who informally rent out a room or portion of their home without structural modifications, and those who’ve allowed family members to occupy part of the property without collecting rent.

For properties that have been converted from rental to primary residence, only periods of qualifying use count toward the 2-year ownership and use requirement, with gains allocated proportionally between qualifying and non-qualifying periods. When applying for a mortgage, lenders may request documentation of CRA self-employment income if rental activities are substantial enough to be considered business income rather than passive rental income.

Scenario	Principal Residence Exemption Impact	Capital Gains Consequences
Legal self-contained suite (basement apartment, laneway home)	Deemed disposition triggered; each unit treated separately; only primary unit qualifies	Proportional calculation required; rental suite portion subject to capital gains tax upon sale
Informal rental (spare bedroom, shared kitchen)	Entire property retains PRE if rental remains ancillary, no structural changes, no CCA claimed	Full exemption preserved when conditions met
Family member occupancy (adult child, aging parent, no rent)	Full PRE eligibility maintained; occupancy satisfies ordinarily inhabited test	Zero capital gains exposure on entire property

When you may lose part of the exemption (change‑in‑use, CCA claims, second property)

Although you’ve successfully rented out your basement for years without tax consequences, three specific triggers can destroy part—or potentially all—of your principal residence exemption.

The most insidious aspect is that two of these triggers activate automatically without requiring you to take any affirmative action beyond the initial decision to generate rental income.

The three exemption-destroying triggers:

Claiming CCA on the rental portion permanently disqualifies that space from principal residence exemption eligibility, creating recapture obligations upon sale.
Structural modifications that make space “more suitable for rental purposes” trigger deemed disposition under change-in-use rules, regardless of CCA claims.
Owning multiple properties forces you to designate only one as your principal residence annually, proportionally exposing the rental suite to capital gains.
Section 45(2) election postpones deemed disposition for four years but requires complex tax planning to execute properly. Even when fully exempt, you must still report the disposition to the CRA starting from the 2016 tax year.
Basement conversions almost universally constitute substantial rather than ancillary changes, triggering immediate tax consequences.

Before creating a rental suite, review your mortgage terms carefully, as many lenders require written consent before allowing rental income from your principal residence.

Record‑keeping and documentation CRA expects if you are audited about suite use

Every tax optimization you’ve executed to preserve your principal residence exemption—deliberately avoiding CCA claims, maintaining ancillary-only renovations, carefully designating properties—collapses instantly if you can’t produce the paper trail proving you actually followed those strategies, because CRA auditors operate on a presumption-of-guilt model where absence of documentation equals taxable income that you conveniently “forgot” to report.

Your record‑keeping arsenal must include:

All T776 rental forms filed annually, cross-referenced with bank deposits showing reported CRA rental income suite amounts match actual receipts
Expense receipts with proportional allocation notes distinguishing personal costs from rental deductions
Fair market value appraisals dated precisely when conversion occurred, not conveniently backdated post-audit
Lease agreements proving ancillary use, demonstrating rental portion remained secondary to your residence
Zero CCA claim documentation, protecting principal residence exemption eligibility throughout ownership

The documentation must demonstrate your rental unit meets the self-contained residence definition with private kitchen, bath, and living area if you’re claiming any rebates or navigating conversion scenarios that could trigger additional scrutiny. Beyond tax implications, maintaining comprehensive records also protects you during the home purchase process since buyers and their legal representatives will scrutinize closing costs and property status during settlement to ensure the rental suite’s existence doesn’t create unexpected financial obligations or title complications.

Interactions with land‑transfer tax, HST housing rebates, and other major programs

How does preserving your principal residence exemption interact with the land-transfer tax refunds you claimed at closing, the HST housing rebates your builder assigned to reduce your purchase price, or the first-time buyer credits that shaved thousands off your acquisition costs—particularly when you now want to add a rental suite to that same property?

Here’s what survives scrutiny:

Your first-time buyer tax breaks stay intact when you later add a rental suite to your principal residence.

Principal residence exemption operates independently of land transfer tax status—your first-time buyer exemption doesn’t evaporate when you later rent a suite
HST housing rebates for owner-occupied homes remain valid unless you misrepresented occupancy intent at purchase; subsequent suite rental doesn’t trigger retroactive clawback
Land transfer tax exemptions depend on purchase-time principal residence designation, not ongoing use
GST/HST rental property rebates apply only to purpose-built multi-unit structures, not single homes with secondary suites
Provincial rebate programs exclude duplexes and single dwellings entirely
New Brunswick’s purpose-built rental housing HST rebate program, which offers a 100% rebate of the provincial HST portion for construction starting between November 15, 2024, and December 31, 2027, similarly does not extend to single-family homes with basement suites
Ontario’s ongoing efforts to build 1.5 million homes by 2031 include support for innovative housing solutions such as secondary suites that help improve affordability without compromising homeowner tax benefits

Questions to ask a tax professional before relying on PRE with a rental suite

Before you file that T1 claiming full exemption eligibility, demand answers:

Does my rental suite trigger structural change-in-use reporting under subsection 45(1), permanently tainting my principal residence exemption even after I stop renting?
Have I claimed CCA depreciation on the suite portion, creating recapture obligations that override exemption eligibility?
Does my suite’s income qualify as ancillary use, or does square footage proportion force partial gain recognition?
What documentation proves occupancy intent versus investment motive?
How do provincial reassessment triggers interact with federal exemption calculations?
Will renting beyond 14 days per year disqualify my exemption under local treasury guidelines that may lack statutory authority?
Can I verify that my suite meets ceiling height requirements and has proper permits on municipal record to avoid insurance claim denials that expose undisclosed rental income?

Disclaimers and why PRE planning with suites should not be a DIY project

Because the deemed disposition rules under subsection 45(1) operate on a facts-and-circumstances analysis that CRA applies inconsistently across field offices, and because the interaction between change-in-use elections, CCA recapture obligations, and proportional PRE calculations creates mechanical complexity that most homeowners fundamentally misunderstand, treating rental suite tax planning as a weekend research project is financial malpractice against your own net worth.

Critical disclaimers for principal residence exemption rental suite planning:

CRA field officers maintain discretion to apply deemed disposition provisions differently based on property-specific circumstances you can’t predict from online research.
Elections filed incorrectly become irrevocable, permanently eliminating depreciation deductions or triggering taxable gains you could have avoided.
Secondary housing unit classifications depend on structural characteristics requiring professional assessment, not self-diagnosis.
Pre with rental suite calculations demand mechanical precision across multiple tax years, incorporating recapture provisions most homeowners can’t identify independently.
Provincial programs create layered federal consequences requiring integrated analysis.
The exclusion can only be claimed once every 2 years, limiting your ability to restructure rental arrangements through property transfers without permanent tax consequences.
Just as lenders verify source of funds from international jurisdictions with heightened scrutiny regardless of dollar amount, CRA applies proportional gain calculations to rental income regardless of suite size or revenue generated.

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