This is a good article I found on the MoneySense website
When you buy real estate you expect that, over time, it will appreciate in value. If you sell that property for more than you paid, you will have an appreciable gain in value and this triggers a taxable capital gain for the Canada Revenue Agency (CRA).
Your home can be an effective tax shelter, but other forms of real estate can attract capital gains taxes. Here’s what you need to know about some of the more nuanced real estate scenarios.
Many readers want to know if their home will continue to qualify for the principal residence exemption if they rent out a portion of their house. Their concern is prompted by stories of people who lost this exemption after years of renting out their basement.
While it’s true—you can lose your principal residence exemption—it really only happens if you rent out more than 50% of your home, or when you decide to claim capital cost allowance on the portion of your home that is the rental. The CRA recognizes that, over time, depreciable property will become obsolete. Believe it or not, this also applies to real estate. Because of this you are well within your right to offset this loss in value by deducting the depreciation over a period of several years. This deduction is the capital cost allowance (CCA). However, if you claim CCA on your home, you are effectively telling the taxman that this property is used to produce income, and you use lose the opportunity to claim a capital gain, which is taxed much more favourably than income.
But what if you buy a duplex or fourplex and live in one unit while renting out the others? Can you deduct costs, including CCA, to offset the rental income you collect each year and still claim a principal residence exemption? Yes: but you’ll need to clearly document what portion is for personal use and what portion is rental. Only deduct expenses for the rental portion. When you sell, you can claim the principal residence exemption for the portion that was for personal use. To understand how this all works, consider the following:
• Buy a duplex for $400,000.
• Rent out one unit (for $1,500 per month) and live in another.
• Each year you report your annual rental income (about $18,000) and then offset these earnings with expenses associated with the unit. Remember: you cannot deduct expenses, including CCA, for the personal portion of the duplex.
• After four years you sell the duplex for $500,000.
• Because 50% of the property is used for personal use, you can shelter 50% of the $100,000 capital gain.
But be forewarned: CRA is cracking down on income generated from real estate, and in order to qualify for the principal residence exemption no more than 50% of a principal home can be used for rental purposes. For people thinking of buying and investing homes with a personal use portion you may want to seek out professional advice.
Read on here http://www.moneysense.ca/columns/can-you-avoid-capital-gains-tax/