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Change in Use

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Personal Tax
Real Estate -> Change in Use of Real Property

Change in Use - What Happens if I Move into my Rental Property, or Start Renting out my Home?

Deemed disposition

When there is a change in use of real estate, either from income-producing to personal-use (e.g., principal residence or cottage/second home), or from personal-use to income-producing, there is a deemed disposition.  The owner is deemed to have disposed of the property (land and building), and to have immediately reacquired it, with both transactions done at fair market value.

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Change in use from income-producing to personal-use

When the property use changes completely or partially from income-producing to personal use, the deemed disposition can result in a capital gain.  This is calculated by deducting the adjusted cost base of the property from the fair market value at the time of change in use.  Where only a part of the property has changed use (duplex, fourplex, basement suite, etc.), then there will be a deemed disposition only for that portion of the property.

When there is a capital gain, under certain circumstances the gain can be deferred by making an election under subsection 45(3) of the Income Tax Act.  The election may not be made if capital cost allowance (CCA) has been claimed on the property for any taxation year ending after 1984.  If any CCA was claimed prior to 1985, this may result in a recapture of that  CCA.  To make the election, a letter should be filed with the income tax return for the year in which the property is eventually sold (or earlier if demanded by CRA).  Further information on this election can be found in CRA Guide T4037 Capital Gains.

Change in use from personal-use to income-producing

When the property use changes from personal-use to income-producing , the deemed disposition can result in a capital gain.  This is calculated by deducting the adjusted cost base of the property from the fair market value at the time of change in use.  The fair market value at the time of change in use is the new adjusted cost base of the income-producing property.  Note that if the property is not located in Canada, and the new adjusted cost base is over $100,000 in Canadian dollars, there will be a requirement to complete form T1135 foreign income verification statement each year in the future while the property is owned.

Any gain resulting from this deemed disposition can be eliminated by the principal residence exemption (PRE) if the property has always been the taxpayer's principal residence.  If the property has been the principal residence for only a portion of the time it has been owned, then the gain could still be partially eliminated by the principal residence exemption.

The taxpayer may also defer recognition of the resulting capital gain (if any) by electing under subsection 45(2) of the Income Tax Act to be deemed not to have made the change in use.  This defers the recognition of the capital gain until the property is ultimately sold.  This election cannot be made if there is only a partial change in use of the property.  The election should be made when the change in use happens.  Once this election has been made, the property can still qualify as the taxpayer's principal residence for up to 4 taxation years, even if the property is not inhabited during those years by the taxpayer.  However, the taxpayer must still be a resident or deemed resident of Canada during those years in order to designate the property as the principal residence.

For example, assume a taxpayer rented out their principal residence on June 1, 2006, after living in it since 1996, and moved into a friend or relative's home.  The taxpayer filed a s. 45(2) election for the 2006 taxation year.  The taxpayer sold the former principal residence in 2012.  No capital cost allowance was claimed during the years 2006 to 2012 while the home was rented out.

If the election had not been filed:

bullet There would have been a deemed disposition in 2006 at fair market value (FMV), with any gain sheltered by the PRE.
bullet When the home was subsequently sold in 2012 there would be a capital gain based on the increase in FMV since the deemed disposal.

Because the election was filed:

bullet The change in use was deemed not to occur, so there was no deemed disposal in 2006.
bullet When the home was subsequently sold in 2012 there would be a capital gain based on the increase in FMV since the home was purchased in 1996.  The number of years sheltered by the PRE would be 11 (1996 to 2006 inclusive) plus 1 (normal rule for PRE) plus 4 (re s. 45(2) election), for a total of 16 years.  The home was owned for 17 years (1996 to 2012 inclusive), so the PRE would shelter 16/17ths of the total gain.

The property may qualify as the taxpayer's principal residence for more than 4 taxation years (under certain conditions) if the reason for the change in use is that the place of employment of the taxpayer or the taxpayer's spouse or common-law partner has been relocated.  The conditions (as per subsection 54.1 of the Income Tax Act) include:
    a.    the employer must not be related to the taxpayer or the taxpayer's spouse or common-law partner;
    b.    the property must be at least 40 kilometres farther from the new place of employment than is the subsequent residence; and
    c.    either 
        i.    the taxpayer resumes inhabitation of the property during the term of employment with the same employer, or by the end of the taxation year following the year in which the employment terminates; or
        ii.    the taxpayer dies during the term of the employment.

If the s. 45(2) election was not made when the change in use occurred, CRA might accept a late election under certain circumstances, one of which is that no capital cost allowance has been claimed on the property since the change in use occurred and during the period in which the election is to remain in force.  For further information on late-filed elections, see the CRA Information Circular 92-1, Guidelines for Accepting Late, Amended or Revoked Elections.

More CRA Resources:

bulletS1-F3-C2: Principal Residence - includes information on change in use.
bullet Changing all your principal residence to a rental or business property

What if I rent out part of my home or cottage, such as a basement suite?

When you rent out a part of your home or cottage, you are considered to have changed the use of that part of the home from personal-use to rental property.  Depending on the circumstances, when you eventually sell your home, or have a deemed disposition because you stop renting part of it, you may have to report a capital gain on the portion of your home that you rented out.

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The CRA Rental Income Tax Guide, T4036, and S1-F3-C2: Principal Residence (see partial changes in use) state that if all of the following conditions are met, you will not be considered to have a change in use:
    - the part of the home used for rental purposes is small in relation to the size of the whole property,
    - you do not make any structural changes to the property to make it more suitable for rental purposes, and
    - you do not claim any capital cost allowance on the part you are using for rental purposes.

If all of the above conditions are met, you will not have to report a capital gain when the property is sold or the rental is stopped.  Otherwise, you will have to report a capital gain based on the portion of the house that was rented.

If you rent out a part of your home, CRA's position is that you may only write off losses against other income if you have a "reasonable expectation of profit" from the property rental.

See all our articles related to Property Rentals.

 

Revised: April 05, 2014

 

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