If you have left Canada or bought a new property and you have decided to rent your old property that you used to be your primary residence, you will need to make a change in use. This is the transformation of a primary residence into a good income earning (rental income).
Deemed sale
When such a situation arises, for the purposes of the Income Tax Act, you are deemed to have sold your property at its fair market value (FMV) and this must be reported on your Canadian income tax return. Because the change in use is a form of deemed disposition (also known as a “deemed sale”), it may result in a capital gain if you are not able to exempt it in full.
You will also be presumed to have acquired it again at that same FMV. Thus, upon the actual disposition of your property, the capital gain will be adjusted based on this deemed sale. This same presumption also applies to partial changes of use, for example the conversion of part of a house to a duplex.
If the change takes the opposite path instead, transforming an asset used to earn income into a principal residence, the same rules will apply. However, you can normally make a tax election that will defer the deemed disposition.
Postponement of deemed disposition
If you start renting a property that previously served as your principal residence, you can defer the deemed disposition by making an election under subsection 45 (2) of the Act. For this election to be valid, a letter must be prepared and attached to your Canadian income tax return in the year of the change in use.
A late election may be accepted by the CRA, but penalties may apply. In addition to not being deemed to have made a change in use, this choice allows you to designate your old property as your primary residence for four additional years. However, this election will be overridden if you use capital cost allowance in a subsequent year.
Conversely, if you begin to normally live in your previously rented property, you can make the election under subsection 45 (3) of the Act. This choice will also allow you to defer the deemed sale and to designate this property as your principal residence for four additional years. For this election to be valid, no capital cost allowance must have been used throughout the rental period.
Finally, it should be noted that these choices are only available to residents of Canada and are intended for complete changes of use only.
To find out more, do not hesitate to contact one of our tax experts. We can assist you during a change of use and validate the relevance of making the available tax choices.