Have you changed your principal residence to a rental property, or vice versa? If so, you may be subject to capital gains tax implications.
Canada Revenue Agency (CRA) says that you may be considered to have sold all or part of your property even though you did not actually sell it.
You may have a deemed disposition on the property in the following circumstances:
1.You change all or part of your principal residence to a rental property; or
2.You change your rental property to a principal residence.
Whenever there is considered to have been a change in use, as above, you are considered to have disposed of the property at its Fair Market Value (FMV) and to have reacquired it at the same FMV. Any capital gain as a result of this deemed disposition must be reported on your personal tax return in the year the change in use occurs. Of course, you do not have to pay tax on any capital gains for the years that you have designated the property as your principal residence, but only for the years that it was not your principal residence. Also, capital losses cannot be claimed on your principal residence.
There are, however, ways you can get away with not having tax implications in any of the above situations.
Change in use from principal residence to rental or business property
You can make an election to defer the capital gains tax otherwise payable upon change in use until the property is actually sold. The deferral of paying the tax is achieved by filing an election with CRA under subsection 45(2) of the Income Tax Act. In many situations, the capital gains tax can be avoided entirely. Note – the election cannot be made when there is only a partial change in use.
Filing the election allows your property to qualify as your principal residence for an additional four years, even though you do not inhabit it during that time. Of course, having your property qualify as your principal residence for four more years allows you to claim the principal residence exemption for those same years.
For the election to qualify, you must:
1. Report the rental activity on your personal tax return;
2. Cannot claim Capital Cost Allowance (CCA) on the property;
3. Be a resident or deemed resident of Canada during those years; and
4. Not designate another property as your principal residence for those years.
The most common situation where this applies is when a taxpayer owns a home that was there principal residence and they move out to a friend’s or relative’s home.
There are situations where you can extend the election beyond the four years when the reason for the move was because the location of place of employment of the taxpayer or their spouse/common-law partner has been relocated. The details of that situation are beyond the scope of this writing and will not be discussed.
Change in use from rental or business property to principal residence
When the property changes, completely or partially, from a rental or business property to a personal use property, the deemed disposition occurs with the same tax triggers in the same manner as discussed above.
You can make an election to defer the capital gains tax otherwise payable upon change in use until the property is actually sold. The deferral of paying the tax is achieved by filing an election with CRA under subsection 45(3) of the Income Tax Act.
Similarly, filing the election allows your property to qualify as your principal residence for an additional four years, even though you do not inhabit it during those years. Again, the capital gains tax can be avoided entirely in some situations.
The election cannot be made if CCA has been claimed on the property for any taxation years ending after 1984. If CCA was claimed for any taxation years prior to 1985, you may have to report recapture of that CCA.
Late filing of the election
Ideally, you make the election when the change in use has occurred. However, CRA may accept late filed elections under certain circumstances.
Filing the election
If you have had a change in use on your property and would like to defer or entirely avoid capital gains tax, we would be pleased to assist you with the process.