Usually not. The Canada Revenue Agency allows most homeowners to rent out part of a house and still shelter the whole property under the principal residence exemption, so no capital gains tax applies when you sell. Three conditions produce that result, and each one has to hold for the entire period you collected rent.
The first is that the income-producing use stays ancillary to your main use of the property as a home. Renting a bedroom to a student while your family lives in the rest of the house clears that easily. The second condition is about the building. Where you have made no structural change, the CRA treats the property as unchanged for tax purposes. Adding a separate entrance or a second kitchen fails this test, as does moving walls to carve out a self-contained unit. The third is capital cost allowance, the depreciation deduction available against rental income. Claim it even once and the protection unwinds retroactively to the date the use changed.
When part of the house becomes a separate rental
Miss any of those and you have what the CRA calls a partial change in use. You are deemed to have sold the rented portion at fair market value on the day the use changed, which establishes a new cost base for that share. On an eventual sale the gain gets split. The part you occupied remains exempt under the principal residence exemption, while the rented share is taxed as a capital gain, with half of it added to your income at your marginal rate. Square footage is the usual way to divide the property, though the CRA accepts any reasonable basis.
A Toronto house with a legal second suite in the basement is the common version of this. Such a unit has its own entrance and kitchen by definition of what makes a basement apartment legal in Toronto, which means the structural test fails and the owner carries a taxable portion from that point forward. Since 2019 the subsection 45(2) election has been available on partial changes in use. Filing it can defer the deemed sale and keep the principal residence designation across the full property for up to four additional years, provided you claim no capital cost allowance.
Reporting still applies when nothing is owed. Any disposition of a principal residence belongs on Schedule 3 of your return with Form T2091, and skipping it risks penalties and a denied exemption. Since the outcome turns on when the rental began and how much of the house it occupies, the question is worth putting to an accountant before the renovation rather than after the sale.
Related reading: Should You Sell or Rent Out Your Condo in Toronto?, Do You Pay Capital Gains Tax Selling Your Ontario Home?, and What Makes a Basement Apartment Legal in Toronto?
