When a property that was used as a primary residence or cottage for personal use is converted into an income-producing property, such as a short-or long-term rental, there is a change of use of the property.
Without tax planning and elections, a change of use results in a deemed disposition at fair market value of the property (or part of the property if the change is partial) and a new acquisition at the same value. Therefore, even if the property is not actually sold, tax may be payable on the capital gain from the deemed disposition.
In some cases, if the taxpayer qualifies for the primary residence exemption, the tax liability can be eliminated. However, without tax planning, the entire increase in value of the property (or part of the property if the change is partial) after the change of use is subject to tax, given that the residence is used for income purposes.
What are the tax deferral options?
To avoid the deemed disposition of the property and its undesirable tax consequences, it is possible to make a tax election. This election allows the taxpayer to defer capital gains taxation until the actual sale of the property. In addition, the election allows the property to retain its primary residence status, and therefore benefit from the primary residence exemption for four additional years during which the property (or part of it) is used for income-producing purposes.
Primary residence status can be extended beyond the four-year period for taxpayers whose employment requires them to live away from their primary residence for an extended period.
What conditions must be met?
For the election to be valid, the following conditions must be met:
- The taxpayer must be a resident or deemed to be a resident of Canada.
- No capital cost allowance is taken for the year in which the change of use takes place or for subsequent years.
- The taxpayer must attach a signed letter of explanation to their tax return for the year of the change of use.
Do these rules apply to a partial change of use?
A partial change of use may also be eligible for this tax election if the above conditions are met.
It is important to analyze whether a tax election can be advantageous in deferring tax on a complete or partial change of use of a property. The tax specialists at DS Lawyers will be pleased to discuss whether this is the right choice for you.