The Scenario
John and Jane each purchase a real property in Ontario in 2003, to which they take title in their names alone. John purchases a residential property for $2,000,000 (“John’s Property”) and Jane purchases a cottage property for $1,000,000 (“Jane’s Property”). In 2006, John and Jane become common law spouses, and go back and forth between living at their respective properties – typically John’s during the Fall and Winter months and Jane’s during the Spring and Summer months. John and Jane never enter into any domestic agreement. Both were previously married and have children from their prior marriages, who are their primary beneficiaries and not each other.
In February 2026, John suddenly passes away. John leaves a Last Will and Testament, which appoints his son, Andrew, as the sole executor and trustee of his estate. Andrew schedules a meeting with an accountant to discuss the preparation and filing of John’s Terminal (T1) Tax Return (“Terminal Return”), which must be filed and taxes paid no later than April 30, 2027. As at the date of John’s death, his property is worth $4,000,000. During Andrew’s meeting with the accountant, the accountant recommends that on the Terminal Return, the principal residence exemption (“PRE”) be claimed in respect of John’s Property for every year it was owned, being 2003 until 2026.
As John’s Property has appreciated $2,000,000 in value, and considering that no capital improvements had been made to bump up the adjusted cost base, there would be a capital gain of $2,000,000, $1,000,000 of which is considered taxable income, and of which approximately $500,000 would be owing in tax to Canada Revenue Agency (“CRA”). However, by claiming the PRE for every year in which John’s Property was owned, there would be no tax owing to CRA.
One PRE Per Family Unit
The issue to consider is as follows: in accordance with section 54 of the Canadian Income Tax Act (the “Act”), married and common law spouses, who are considered one family unit, can only designate one principal residence between them for any given tax year. In that regard, if John and Jane are considered common law spouses under the Act, as a result of Andrew, in his capacity as John’s executor and trustee, claiming the PRE on John’s Property from 2006 until 2026, Jane will not be able to claim the PRE on her property during this period, following the sale of her property or by her estate at the time of her death.
Unintended Consequences
If Jane’s Property has appreciated in value between 2006 and 2026, upon the sale of her property or the deemed disposition thereof on her death, there would be a capital gains tax owing to CRA for approximately 25% of the appreciated amount. That being said, Jane may still be able to claim the PRE on her property between 2003 and 2006, as she and John were not common law spouses during those years and therefore are entitled to each have the ability to claim a PRE. The tax filings made by John can cause there to be an unfair outcome to Jane and to her estate, and possible litigation.
While not the focus of this blog, pursuant to section 248 of the Act, a common law spouse is defined as an individual who cohabits in a conjugal relationship with another person and meets one of three criteria, the first of which is that the common law spouse has been in a conjugal relationship for at least 12 months. The Court considers several factors when determining the existence of a conjugal relationship, such as whether the couple lives together, whether they participate in community events, whether they prepare meals together, whether they share household maintenance duties, and whether they financially support each other.
Key Takeaway for Estate and Trust Planning Purposes
As shown in the example above, spouses who each own their own respective properties in Ontario during an overlapping time period, risk one claiming the PRE following the sale of their property, or on their death, for the years in which the property was owned and the spouses were together. In that case, the other or surviving spouse will lose the opportunity to claim the PRE following the sale of their property or on their death, for those same years, which may be very consequential if that property has appreciated in value during the overlap period and where they are not the beneficiary of each other’s estate and have other beneficiaries.
Where this is the case, married and common law spouses who do not have common beneficiaries but instead, by way of example children from a prior relationship, should consider entering into a domestic agreement, which addresses the control of the allocation of the available PRE years. The notion would be that the available PRE should be allocated between the spouses’ properties in the manner that minimizes the aggregate income tax liability of the spouses, having regard to the accrued gain attributable to each property, and possible other tax considerations.
Further, any domestic agreement entered into by common law spouses should coordinate with their Wills and direct their executors and trustees to consider any such agreement and the surviving spouse’s property when determining whether to claim the PRE on the deceased spouse’s property, and for what year(s). It can also provide for compensation to be paid where a spouse does not have the benefit of claiming the PRE on the property they own but instead it is claimed on the other spouse’s property.
It is recommended that spouses in these situations consult an estate planning lawyer during their lifetime(s), and particularly when they each own separate properties; otherwise, without proper planning in place, on the sale of one of their properties or on the death of the first spouse, there may be a dispute in relation to the PRE being claimed in relation thereto, as the Act is clear in that it can only be claimed by spouses on one single property in any given tax year.
For Further Reading
Check out some of our firm’s previous blogs on capital gains tax and on the principal residence exemption
Update on The Capital Gains Exemption and Qualified Small Business Corporation Shares – March 25, 2026
Inheritance Tax, Wealth Tax and More Capital Gains Tax: The Future of Canadian Taxation? – March 3, 2020
The Principal Residence and Capital Gains Tax – New Rules, New Pitfalls – May 16, 2017
— Josh Cohen