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Before making a major financial decision you
should consult a qualified professional.
Although this article discusses only the change in use of real estate
properties, the change in use rules apply to other types of property as well
- see the definition of Property
in our Glossary.
When there is a change in use of real estate, either from
income-producing to non-income-producing personal-use (e.g., principal residence or
cottage/second home), or from personal-use/non-income-producing 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.
How to Determine Fair
Market Value (FMV)
In order to determine the FMV upon a change in use, the taxpayer should get a
professional appraisal. If an appraisal isn't done at the time of change
in use, a professional appraiser can probably provide an appraisal for the date
of the change in use. From looking at Tax Court cases, it's obvious that
CRA does FMV appraisals long after the fact. We found no cases where the
taxpayer used something other than a professional appraisal, so cannot say if
assessment notices or sales of similar properties would be acceptable to
CRA. See also the special rules for determining FMV/new capital cost when
there is a change in use from personal use to
income-producing.
GST/HST
on Change
in Use From Short-Term Rentals to Long-Term Rentals or Personal-Use (Principal Residence or
Cottage/2nd Home)
Besides being a deemed disposal for income tax purposes (see below), there are GST/HST consequences if a short-term rental property, such as an
Airbnb property, is converted to a long-term rental, or if it is converted for
personal use. GST or HST may be payable on the market value of the
property at the time of the conversion. See:
If a short-term rental is converted to personal use, it is also a deemed
disposition for income tax purposes (see below).
Apparently, in BC there are 11,000 short-term rentals operating illegally -
i.e., without a business licence. See Thousands of short-term rentals operating illegally in B.C., data shows,
by Amy Judd of Global News. Unless action is taken by these short-term
rental operators, they will be denied deduction of any expenses from
their rental income for 2024, under changes from the Federal 2024 Budget. See Denial of Expenses for Non-Compliant Short-Term Rentals.
The action they take could be very costly in terms of GST payable.
Unfortunately, many government policies are discouraging investors from
becoming landlords, and discouraging development of purpose-built rental
properties, even though the government has good intentions. For instance, a
major property developer in Metro Vancouver has decided they cannot proceed with
a 1,200+ purpose-built rental home project. This is because the
combination of BC policies and recent legislative changes, CMHC "median
rates" and City of Burnaby policies have made such a project not viable
economically. See Bosa
Properties Says Burnaby Policies Make Purpose-Built Rental Projects "Unbuildable".
Tax Tip: Before changing your Airbnb to a long-term rental or
personal-use property, get advice from a tax professional!
Change in Use
From Income-Producing Rental Property to Personal-Use (Principal Residence or
Cottage/2nd Home)
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.
S. 45(3) Election - Defer Capital Gain
Until Property
Sold
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. S. 45(4) of
the Income Tax Act does not allow the election to be made if
capital cost
allowance (CCA) has been claimed "in respect of 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.
This election is only available if the property becomes, or becomes part of,
the principal residence of the taxpayer.
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 within 90 days of a formal demand for the
election from CRA.
If a Quebec tax return is also being filed, a copy of the election
should be sent to Revenu Quebec.
Further information on this election can be
found in CRA Guide T4037
Capital Gains.
Change in
Use From Personal-Use (Principal Residence or Cottage/2nd Home) to Income-Producing
Rental Property
When the property use changes from personal-use (non-income-producing) 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. However, there are special rules to determine deemed capital cost
of the depreciable portion of the property, if the fair market value of the
depreciable property (building, for example) is greater than its cost to the
taxpayer. See CRA's Change
in use rules regarding CCA, deemed capital cost, and recapture. See
also the Tax Court Case Donaldson
v. The Queen, 2016 TCC 5.
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.
The deemed disposition must be reported on the tax return. Any gain resulting may 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. Starting with the 2016 taxation year, the
disposition will have to be reported on the taxpayer's income tax return
even if all of the gain is exempt due to the PRE. Check our article on
the principal residence
exemption re other changes announced in October 2016.
The net rental income must be reported annually on the taxpayer's tax
return. See links at bottom to relevant articles as well as CRA
information.
S. 45(2) Election - Defer Capital Gain Until Property
Sold
When non-income-producing property has been converted to income-producing, the taxpayer may 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. The election should be made
when the change in use happens. This election can be made for any
property, not just the principal residence.
If you make this election, you still have to report the net rental income you
earn, and you cannot claim capital cost allowance (CCA) on the property.
To make the election, attach a letter signed by you to your tax return
for the year in which the change in use occurs. Describe the property
and state that you want subsection 45(2) of the Income Tax Act to apply.
S. 45(2) Election for Principal Residence
Once this election has been made for a residence that was the taxpayer's
principal residence, the property can still qualify as the 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. This can only be done if no other
property is designated as the principal residence for that same period.
If a Quebec tax return is also being filed, a copy of the election
should be sent to Revenu Quebec.
Tax Tip: This can be complicated - you may need to
consult with a tax professional!
S. 45(2) Late Election re Change in Use
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 Late, Amended or Revoked Elections.
Can I Retroactively Change My CCA Claims for Prior Years?
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:
There would have been a deemed disposition in 2006
at fair market value (FMV), with any gain sheltered by the principal
residence exemption (PRE).
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:
The change in use was deemed not to occur, so there
was no deemed disposal in 2006.
When the home was subsequently sold in 2012 there
would be a capital gain based on the increase in FMV (FMV = the
proceeds of sale) 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:
the employer must not be related to
the taxpayer or the taxpayer's spouse or common-law partner;
the property must be at least 40
kilometres farther from the new place of employment than is the subsequent
residence; and
either
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
the
taxpayer dies during the term of the employment.
Change in Use of Part
of a Property
Under previous rules, a taxpayer could not elect out of the
deemed disposition that arose on a change in use in part of a property.
The Federal 2019 Budget
included a provision to allow an owner of a multi-unit residential property to
make use of the s. 45(2) or 45(3) elections. The legislative change for
this was included in Bill
C-30, Budget Implementation Act, 2021, No. 1, which received Royal
Assent June 29, 2021. This revision allows the election for a change
in use of part of a property that occurs after March 18, 2019.
To quote from Budget
2019 Tax Measures Supplementary Information: To improve the consistency of the tax treatment of owners of multi-unit
residential properties in comparison to owners of single-unit residential properties,
Budget 2019 proposes to allow a taxpayer to elect that the deemed disposition
that normally arises on a change in use of part of a property not apply.
What if I Rent Out
Part of My Home or Cottage/2nd Home, or Have a Home Office?
When you rent out a part of your home or cottage, or convert
part of your home to a home office, 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.
The CRA Rental
Income Tax Guide, T4036, and S1-F3-C2: Principal Residence (links at bottom -
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.
What if the Use of My
Property Changes Constantly?
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