Selling a Rental Property in Canada

Introduction

Selling a rental property in Canada can trigger significant tax consequences. Many property owners focus on market value and profit but underestimate the impact of capital gains tax and the recapture of depreciation previously claimed through Capital Cost Allowance. The Canada Revenue Agency treats rental properties differently from principal residences, meaning gains are generally taxable. Understanding how the gain is calculated, how recapture works, and what reporting obligations apply is essential to avoid unexpected tax liabilities.

Capital Gains on Rental Property

When you sell a rental property, the primary tax consideration is capital gains.

The capital gain is calculated as:

Proceeds of disposition
Minus adjusted cost base
Minus selling expenses

The adjusted cost base includes the original purchase price plus capital improvements such as renovations that increased the property’s value or extended its useful life. Routine repairs and maintenance do not increase the adjusted cost base.

In Canada, 50 percent of the capital gain is taxable. This taxable portion is added to your income for the year and taxed at your marginal rate.

Recapture of Capital Cost Allowance

If you claimed Capital Cost Allowance on the rental property over the years, part of the sale may trigger recapture.

Recapture occurs when the selling price of the building portion exceeds its undepreciated capital cost balance. The recaptured amount represents depreciation previously deducted and is included fully as income, not as a capital gain.

This can significantly increase the total tax bill because recapture is taxed at your full marginal rate.

The land portion of the property is not depreciable and therefore not subject to recapture.

Allocation Between Land and Building

When selling a rental property, the sale price must be reasonably allocated between land and building.

Because land is not depreciable, allocating too much value to the building may increase recapture exposure. However, allocations must be reasonable and reflect fair market value, as the CRA can challenge aggressive allocations.

Proper documentation of valuations helps support the allocation.

Selling Expenses That Reduce Your Gain

Certain costs associated with the sale can reduce the capital gain.

These include:

Real estate commissions
Legal fees
Advertising costs
Mortgage discharge penalties

These expenses are deducted from the proceeds of disposition when calculating the capital gain.

Change in Use Considerations

If the rental property was previously your principal residence or if you converted a principal residence into a rental property, special rules may apply.

A change in use can trigger a deemed disposition at fair market value, creating a capital gain even without a sale. Elections may be available to defer this deemed disposition under certain conditions.

These rules can significantly affect the final tax outcome and require careful analysis.

GST or HST Considerations

In most cases, the sale of a used residential rental property is exempt from GST or HST.

However, if the property is newly constructed, substantially renovated, or classified as commercial property, GST or HST may apply.

Understanding the property’s classification is critical before completing the sale.

Timing the Sale for Tax Efficiency

The timing of a sale can influence the tax burden.

Selling in a year with lower income may reduce the marginal tax rate applied to the taxable capital gain. Spreading gains over multiple years is not typically possible unless structured through installment arrangements.

Proper planning before listing the property can improve the overall tax outcome.

Joint Ownership and Tax Reporting

If the rental property is jointly owned, each owner reports their share of the capital gain and recapture.

Ownership structure determines how income and gains are allocated. It is important that reporting aligns with legal ownership and actual contributions to avoid reassessment.

Impact on Other Benefits and Credits

A large capital gain can increase net income for the year and affect income-tested benefits or credits.

For example, higher reported income may reduce government benefits or increase tax installments in the following year.

Planning for these secondary impacts is part of responsible tax management.

Record-Keeping Requirements

Accurate records are essential when selling rental property.

Maintain documentation of:

Original purchase agreement
Legal fees and closing costs
Capital improvements
CCA claimed each year
Sale agreement and related expenses

Without proper records, the CRA may estimate values in a way that increases taxable amounts.

Conclusion

Selling a rental property in Canada typically triggers both capital gains tax and potential recapture of depreciation. The taxable capital gain represents half of the appreciation, while recaptured Capital Cost Allowance is fully included in income. Proper allocation between land and building, accurate record keeping, and strategic timing can significantly influence the final tax outcome. Understanding these elements before completing a sale helps prevent costly surprises.

Tax Partners can assist you in calculating your capital gain, identifying recapture exposure, and developing a tax-efficient strategy tailored to your situation before and after the sale.

This article is written for educational purposes.

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at info@taxpartners.ca, or by visiting our website at www.taxpartners.ca.

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.