Home ownership is a common financial goal amongst Canadians and many individuals also view housing as a great investment. As a result, many people will purchase a property and use it for both personal and investment purposes at different points during their ownership. If this applies to you, you must ensure that the proper tax elections are filed to prevent any negative tax implications.
Converting a property from a personal-use property to an income-producing property, or vice versa, is considered a change in use. A change in use triggers a taxable event. You are considered to have disposed of your property at fair market value and reacquired it for the same amount. This may require you to report a taxable capital gain on your tax return. You may not have cash available to pay the taxes owing on this deemed disposition since you have not sold the property. Fortunately, there are elections available to defer this change in use.
When changing a property from a personal-use property to an income-producing property, you can file an election under subsection 45(2) of the Income Tax Act. This election allows you to defer the change in use for up to four years and defer paying tax on the deemed capital gain until the property is sold. This election can be very beneficial as it allows you to claim the principal residence exemption on the property during this four-year period, even though you are not residing in it. Similarly, when changing a property from an income-producing property to a personal-use property, you can file an election under subsection 45(3) of the Income Tax Act. This election also allows you to defer paying tax on the deemed disposition until the property is sold. You can also designate the property as your principal residence for up to four years prior to the change in use.
In both situations, you can not claim capital cost allowance (CCA) on the property for the elections to be valid. You can not designate any other property as your principal residence during the applicable four-year period and you must be a resident of Canada during this period if you want to shelter the gain on this property with the principal residence exemption.
The elections under 45(2) and 45(3) must be filed by the due date of the tax return that the change in use occurred. The election is completed by submitting a signed letter to Canada Revenue Agency which provides a description of the property and the date of the change. Late-filed elections may be accepted if no CCA was claimed on the property.
The deemed disposition rules may also apply on a partial change in use if the change is substantial and of a more permanent nature. The rules will not apply if all of the following conditions are met for a change from a personal-use property to an income-producing property:
a) the income-producing use is ancillary to the main use of the property as a residence;
b) there is no structural change to the property; and
c) no CCA is claimed on the property
There will be a deemed disposition on the portion of the property that has been converted to an income-producing purpose. You generally can not make an election to defer the partial change in use.
The above elections can be very beneficial. They allow you to defer recognizing a capital gain until you have cash available to pay the taxes and may allow you to designate the property as your principal residence for up to four additional years. In certain situations, such as if you are moving temporarily for work or family reasons, a timely filed election can ensure that you are not subject to tax on a deemed disposition and may allow you to shelter the entire capital gain from tax on a future sale. We would be happy to assess your options and help you plan for your move.
For more information, please contact firstname.lastname@example.org or 1 844-GYTD-CPA