Change in use rules for property owners

Real estate, including rental and leasing are the top contributors to Canadian GDP ;adding about 14% to total GDP. By derivation this means there is relatively higher transaction activity in the real estate market, some of this activity includes change in use (e.g. personal property to income producing property) for which change in use rules may apply.

It is therefore imperative for property owners to stay abreast of the applicable rules , otherwise costly mistakes can be made. In this article I will explore the following typical scenarios that every residential property owner should be aware.

  1. Changing from principal residence to rental property
  2. Changing from rental property to principal residence

The guiding principle to keep in mind as we go through the above listed scenario is that each time there is change in use of property , a disposition is deemed to have occurred at fair market value , which in effect also means a capital gain/loss is triggered unless of course exempted.

1. Principal Residence to Rental Property

Its fairly common for property owners to move out of their principal residence into another residence , be it to upgrade or downgrade, or even to effect a temporary move for work or for school etc.

When this happens; in most cases the property owner either sells the old property or rents it out. Simply selling will be fairly straightforward from tax perspective ; however should they rent it out , the property is deemed to have been disposed of at its Fair Market Value (FMV).

If the property has always been principal residence , any deemed capital gain will be exempt from tax under the Principal Residence Exemption rules. Nevertheless the disposition still needs to be reported in the year the deemed disposition occurred , otherwise penalties may accrue.

Temporary change in use, how is section 45(2) election useful?

In cases where the property owner is moving out temporarily and therefore rents out the property , whilst temporarily away .The property is deemed to have been disposed of (because of the change in use) and immediately acquired back as rental property.

Because rental properties do not qualify for principal residence exemption, that means should the property increase in value during the period its rented out , that increase in value will trigger taxable capital gains, unless the taxpayer makes an election under section 45(2) of the income tax act.

By making this election, the taxpayer would be deemed to not have changed use of the property and therefore will preserve the principal residence exemption for up to 4 years, this on condition the taxpayer does not claim CCA against the property. Note , an election in this case is simply a letter sent along with the tax return for the applicable year explaining that you are electing under section 45(2)

2. Rental Property to Principal Residence

We have already established that a deemed disposition is triggered in this scenario. Important to note here is that the Principal Residence Exemption doesn’t apply in this case since this would not be personal use property (primary residence) at the time of change in use, which means a taxable capital gain may result.

Again the income tax act allows for deferral of the capital gain until the property is eventually sold , the deferral is effected by making a section 45 (3) election, which is simply a letter the taxpayer sends to CRA making the election. Remember , you can only qualify to make this election if you did not at any time claim CCA against the property.