John and Mary are married and own three properties: their principal residence worth $600,000, a cottage worth $300,000, and a rental property worth $400,000. They sell the cottage for $450,000 after owning it for 6 years. If they designate it as their principal residence for 4 of those 6 years, what portion of the capital gain is exempt from tax?
Correct Answer
C) $125,000
The capital gain is $150,000 ($450,000 - $300,000). Using the principal residence exemption formula: (4 years designated + 1) ÷ 6 years owned × $150,000 = 5/6 × $150,000 = $125,000 exempt. The remaining $25,000 gain is subject to capital gains tax.
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