A man's hand holds up the house key to a new laneway house in the background of the photo.

Doubling Your Dwellings: Laneway Houses and the Principal Residence Exemption

August 14, 2023

The popularity of detached secondary dwellings (“Laneway House”) has continued to grow in the Lower Mainland since the City of Vancouver approved them in 2009 to promote affordable housing. Laneway houses are typically rented out to supplement the cost of living but are also used to provide accommodation for aging parents, or adult children who can’t afford to purchase their own home yet. 

While there are several tax issues that rise in connection with laneway houses, let’s examine the implications that a laneway house may have on your ability to claim the principal residence exemption (PRE) if you live in Vancouver.

A background on bylaws

Vancouver’s zoning bylaws permit up to three dwelling units on certain single-family lots, which consists of:

  • The main house;
  • A rental suite—an apartment contained within the main house (e.g., a basement suite); and,
  • A separate laneway house, usually located in the backyard of the property.

It’s important to note here that the laneway house is a component of the existing property, hence it can’t be subdivided and sold. This is because the Vancouver zoning bylaws don’t permit the legal title for a laneway house to be severed from the main property/house.

Laneway houses and the principal residence exemption (PRE)

As a homeowner, you may be able to enjoy a partially or fully tax-exempt treatment on the disposition of your home if it qualifies as a principal residence. Although certain other types of property might qualify as a principal residence, in most cases the home must be a capital property of the taxpayer and considered a “housing unit”.

A laneway house would generally be considered to be a housing unit, due to its ability to provide the same type of shelter and comfort as a traditional house. Therefore, your property that includes a main house and a laneway house would be considered to have more than one housing unit, jeopardizing your ability to claim the PRE on the whole property.

Only one of the two housing units can be your principal residence, so you have to pick either the main house or the laneway house to designate as your principal residence. However, a laneway house can only be designated as a principal residence if it’s ordinarily inhabited by:

  • You;
  • Your current or former spouse/common law partner; or,
  • One of your children

Therefore, a laneway house that is used to earn rental income generally can not be designated as a principal residence.

The rest of the property

This is where it gets complicated.

The portion of your property that is land subjacent to the housing unit, plus the portion of any immediately contiguous land that can reasonably be regarded as ‘contributing to the use and enjoyment of the housing unit as a residence’, is generally considered to be part of your principal residence. Whether the land that is subjacent to the laneway house can be considered as contributing to the use and enjoyment of the main house as a residence is currently an open question.

While there are arguments that can be made in support of this position, the CRA has commented that[1]where a portion of that land is used to earn income from business or property, such portion will not usually be considered to contribute to such use and enjoyment.” Therefore, it’s possible that a portion of your land won’t qualify for the principal residence exemption.

As always—keep track of your documentation

Calculating the portion of the gain you realized on the disposition of your home that qualifies for the principal residence exemption is very complex. It requires a reasonable allocation of the sale proceeds and the cost of the property between the main house, the laneway house and the land[2]. It’s important to keep all documents and receipts related to the acquisition of the property and construction of a laneway house on an existing property. 

If you’re considering purchasing a property with a laneway house or building one on your current property, reach out to your DMCL advisor. They’ll make sure you understand all the tax implications of doing so and help you navigate the complexities of doubling your dwellings.

Article written by Nelson Ip, CPA, CGA

[1] Income Tax Folio S1-F3-C2, Principal Residence, P.2.32

[2] Per the preceding paragraph, the land might consist of two portions in which case an allocation must be made to each portion.