Understanding Capital Gains Tax When Selling a Rental Property in Canada
How Capital Gains Tax applies when a rental property is sold for more than its purchase price.
Understanding Capital Gains Tax When Selling a Rental Property in Canada
Case Study: Scenario Overview
Let’s meet John and Mary, a Canadian couple who purchased a rental property in Ottawa, Ontario a few years ago.
They decided to sell it in 2025 after its value increased significantly.
Here’s how the Capital Gains Tax rules apply to their situation.
Step 1: The Purchase Details
Property Type: Rental Property (not their principal residence)
Purchase Year: 2017
Purchase Price: $450,000
Legal Fees & Closing Costs (purchase): $5,000
Total Adjusted Cost Base (ACB):
$450,000 + $5,000 = $455,000
(The Adjusted Cost Base, or ACB, is the original purchase price plus any costs to acquire or improve the property.)
Step 2: The Sale Details
Sale Year: 2025
Selling Price: $750,000
Realtor Commission & Legal Fees (sale): $25,000
Net Proceeds from Sale:
$750,000 − $25,000 = $725,000
Step 3: Calculate the Capital Gain
Capital Gain = Selling Proceeds − Adjusted Cost Base
= $725,000 − $455,000
= $270,000
This $270,000 is the total capital gain — the profit John and Mary made by selling the property for more than what they paid.
Step 4: Determine the Taxable Capital Gain
In Canada, only 50% of a capital gain is taxable.
This means only half of your profit is added to your income for the year and taxed at your marginal tax rate.
Taxable Capital Gain = $270,000 × 50% = $135,000
So John and Mary will each include 50% of this Capital Gains. i.e. $67,500 in their taxable income for 2025 (since the property was jointly owned as per their Title).
Step 5: Estimate the Tax Impact
Let’s assume:
John’s marginal tax rate = 40%
Mary’s marginal tax rate = 35%
Then the estimated tax payable will be:
John: $67,500 × 40% = $27,000
Mary: $67,500 × 35% = $23,625
Total combined tax = $50,625
That means even though they made a $270,000 profit, about $50,000–$55,000 of it goes toward taxes.
Step 6: What If They Renovated the Property?
Suppose John and Mary spent $30,000 on a new kitchen and bathroom renovation in 2021 to increase rental value.
This cost can be added to the Adjusted Cost Base (ACB) — it reduces the taxable gain.
New ACB = $455,000 + $30,000 = $485,000
Revised Capital Gain = $725,000 − $485,000 = $240,000
Taxable Gain (50%) = $120,000
By claiming eligible renovation costs, they reduced their taxable gain by $15,000 (and saved about $6,000 in taxes).
Note: Only capital improvements (that increase value or extend the life of the property) can be added to ACB — not routine maintenance or repairs.
Step 7: Recapture of Capital Cost Allowance (CCA)
If John and Mary claimed depreciation (CCA) on the property over the years to reduce taxable rental income, they must now “recapture” that amount upon selling.
For example:
They claimed $20,000 total CCA over 8 years.
Upon selling, this $20,000 must be added back to income in the year of sale and taxed at regular income rates (not the 50% capital gain rule).
So their total taxable amounts for 2025 would be:
Capital Gain (taxable 50%) = $120,000
CCA Recapture (fully taxable) = $20,000
Total Added to Income = $140,000
Step 8: Reporting the Sale on the Tax Return
In their 2025 T1 personal tax returns, John and Mary must report the sale as follows:
Use Capital Gains (or Losses).
Enter details of the sale:
Description of property
Year of acquisition and sale
Proceeds of disposition ($725,000)
Adjusted cost base ($485,000)
Expenses of sale ($25,000)
Resulting capital gain ($240,000)
The taxable half ($120,000) is carried on to their tax return.
If they had rental income in the year, it is reported separately on — Statement of Real Estate Rentals.
Step 9: Can They Reduce This Tax?
Yes! Here are a few legitimate ways John and Mary can reduce or defer their capital gains tax:
1. Use Capital Losses
If they had previous capital losses from selling stocks or other assets, they can apply these losses against their capital gains to reduce tax.
2. Timing the Sale
Selling in a year with lower income (for example, retirement or maternity leave) can lower the tax rate on the gain.
3. Spousal Ownership Splits
Because they owned it jointly, the gain is automatically split between them — which helps lower tax compared to one spouse owning it 100%.
4. Principal Residence Exemption
If this had been their main home, the gain could have been completely tax-free.
However, rental properties don’t qualify for this exemption unless they were converted back to personal use and properly declared to CRA before sale.
5. Using an RRSP Contribution
They can contribute a large RRSP amount before the deadline to reduce taxable income in the same year the capital gain is reported.
Example:
If John contributes $25,000 to his RRSP, his taxable income drops by that amount — saving around $10,000 in taxes.
Step 10: A Simplified Summary of the Numbers
Estimated tax payable (based on 37% average rate):
140,000 × 37% = $51,800 approx.
Step 11: What Happens if They Reinvest the Money?
Unlike some countries (e.g., the U.S. 1031 exchange), Canada doesn’t allow deferral of capital gains just by buying another rental property.
You’ll pay tax on the gain in the year you sell, even if you reinvest the proceeds elsewhere.
However, using some of the after-tax proceeds to buy a new property under a corporation or set up a holding company could create future tax efficiencies.
Step 12: If They Converted It to Their Home Before Selling
If John and Mary had moved into the rental property and lived in it as their principal residence for at least one year before selling, they could claim a partial Principal Residence Exemption (PRE).
Here’s how it works:
The years they lived in it (say 2 out of 8 total years owned) would be exempt from tax.
The remaining 6 years (when it was rented) would still be taxable.
The gain is then prorated:
(6 taxable years ÷ 8 total years) × $240,000 = $180,000 taxable portion
50% of that ($90,000) added to income.
So living in it even briefly before selling can reduce taxes significantly — as long as you file the change in use form with CRA correctly.
Step 13: Realistic Tax Planning Lessons
This case highlights several important lessons for Canadian property owners:
Always track your Adjusted Cost Base (ACB) — include purchase costs, legal fees, and major renovations.
Keep receipts for all improvement expenses; they can save thousands in tax later.
Understand the CCA recapture rule — every dollar claimed as depreciation must be repaid as income on sale.
Use spousal ownership to balance income and reduce overall tax.
Plan the sale timing around other income sources to manage your marginal tax rate.
Consult a tax professional before selling — mistakes in reporting can lead to CRA reassessments and penalties.
Finally
When you sell a rental property in Canada for more than you bought it, the profit is a capital gain — and only half of it is taxable.
However, many small details — such as improvements, ownership structure, prior depreciation, and timing — can dramatically affect how much tax you ultimately pay.
With smart planning, you can legally reduce your capital gains tax, protect your wealth, and make the most of your investment returns.
In Short
In Canada, growing wealth through real estate is a long game — and smart tax planning ensures you keep more of your profit when it’s time to sell.