Change in Use of Property
Where a property goes from principle residence to rental, or vice versa, it is known as a change of use in the property. When this occurs, there is a deemed disposition of the property. What this means is that the individual who owns the property is deemed to sell and then re-purchase the property. Typically fair market value (FMV) would be the price charged for the purchase, and the sale.
Rental –> Principle Residence
When a home goes from a rental property to a principle residence, there will likely be some taxes owing for the owner. This is because the sale will usually result in a capital gain.
Partial Change of Use
Where a rental property becomes a duplex, or triplex, and the owner still lives in the home, there is a partial change of use. If this were to occur, the property would only be bought, and sold for the portion that was changed.
If there is a partial change of use then the deemed sale will only be for that portion of the property. An example of this would be changing an income producing property into a duplex where the owner lives in one of the newly created spaces while renting out the other.
Principal Residence –> Rental
When a home goes from a principle residence to a rental there likely will be no capital gain and no taxes payable. This is because of the Principle Residence Exemption.
Foreign Ownership
Taxpayers with offshore personal use properties must be careful. A personal use property does not have to be reported on various offshore reporting forms such as the T1135 foreign income verification statement. However, if the property becomes a rental and stops being for personal use, the taxpayer will more than likely have to report it on the previously mentioned form. There may also be a capital gain, and taxes may be owing.
Elections
To defer recognition of a capital gain on a partial change of use, the Income Tax Act allows for an election under subsection 45(3). Further information on this election may be found here: T4037 Capital Gains.
If taxpayers do not want the change of use rules applying to them, there is hope. Once can elect under the Income Tax Act subsection 45(2) which deems the change of use not to have occurred. However, please keep in mind that this election is only for complete changes in use and not partial changes.
The election allows the property to stay the principle residence of the owner for up to 4 taxation years. This is whether or not the owner still lives in the property. Taxpayers should keep in mind that they must remain deemed residents of Canada, and cannot designate any other property as a principle residence.
Income Tax Act subsection 54.1 states that when the change of use is because of employment changes, that property may qualify as a principal residence for more than 4 taxation years.
Elections are usually filed when the change in use occurs. If a taxpayer misses the deadline, the Canada Revenue Agency (CRA) may still allow the election. For more information please see CRA Information Circular 92-1, Guidelines for Accepting Late, Amended or Revoked Elections.
Example
Mr. Smith decides to rent out his home on June 1, 2014. He has lived there since 2004. He contacts a lawyer and is told to file a subsection 45(2) election. He then sells the property in 2020.
Because the election was filed:
- The change in use was deemed not to occur.
- There was no deemed sale in 2014.
- When the home was sold in 2020, there would be a capital gain.
- The number of years that qualify for the principal residence exemption would be 11 (2004 to 2014) plus 1 (regularly allowed by PRE formula) plus 4 (because of election being filed), for a total of 16 years.
- As the home was owned for 17 years, the principal residence exemption would shelter 16/17 of the total gain.
If Mr. Smith did not file the election, there would have been a sale in 2014. It would have occurred at FMV with the possibility that any gain may be able to be offset by the Principle Residence Exemption. If Mr. Smith eventually sells the property, a capital gain will occur.
Please keep in mind that no capital cost allowance was claimed while the home was being rented.
Renting out the Attic / Basement
If Mr. Smith decides not to rent out the whole home, but rather just the attic and/or attic, there is a partial change in use.
However, Mr. Smith may take advantage of certain tax rules that if used, would mean there is no partial change of use. Mr. Smith must meet the following conditions:
- The attic/basement made available for rent represents a small portion of the overall size of the home;
- No upgrades, improvements, renovations, etc. are made to the property for rental purposes; and
- Mr. Smith does not deduct Capital Cost Allowance (CCA) on the attic/basement.
If Mr. Smith abides by the above then there would be no change of use, and no capital gain once the property was sold.
If any of the above scenarios pertain to you, give us a call today to see how we can help!
CRA Resources
Changing all your principal residence to a rental or business property
Guide T4002, Business and Professional Income
T2091(IND)-WS, Principal Residence Worksheet
TI-001, Sale of a residence by an owner builder
Case Law
Donaldson v. The Queen, 2016 TCC 5 – Principle Residence –> Rental
Estate of Lily Bullard v. The Queen, 2004 TCC 294 – Subsection 45(2)
Ellyn v. The Queen, 2014 TCC 125 – Subsection 45(3)
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.
