As you may know, you don’t pay tax in Canada on the sale of your principal residence. But what if the property was your principal residence, but was an investment property by the time you sold it?

Q: I purchased my home 20 years ago for $120,000. Fifteen years later I converted that principal residence to a rental property and purchased a second home to live in. I sold the original home this year for $490,000. How much capital gain will I pay tax on due to that sale? — Tony

A: When you own a home as a principal residence, then convert it to an investment property, then sell it, part of the capital gain is exempt, and part is taxable. The part of the gain associated with the time the home was your principal residence is exempt. The rest of the gain is taxable.

No Taxable Gain on a Principal Residence

When you convert your home to a rental property and it ceases to be your principal residence, it becomes an investment property. In effect, any capital gain associated with the period when it is no longer your principal residence, is taxable.

The way it’s calculated is that you find the total capital gain (generally speaking, the sales price minus your purchase price), multiply by the number of years it was NOT your principal residence, and divide that amount by the number of total years in which you owned the property.

In the case given above, your capital gain would be:

[sale price – purchase price] x [years in which it was a rental] / [total years owned]
= ($490k-120k) x 5/20
= $92,500

Only Half of a Capital Gain is Taxable

However, only 50% of capital gains are taxable, so you’d report only 50% of that as income on your income tax return.

[total capital gain] x 50%

=$92,500 x 50%

= $46,250

You’ll probably pay 34-50% tax on that, depending on your other sources of income. There are other nuances, depending on the costs associated with the original purchase, any renovations you did while you owned the property, and fees and commissions involved in the selling of the house, but that’s the gist.