Rental Properties and Your Home– Unexpected Taxes

At one point or another, most people have thought about renting out the extra rooms in their home to earn some additional cash. CRA has specific rules for when tax payers wish to turn their current residential home into a rental home and vice-versa. If not carefully reviewed, there can be unfavorable results for the tax payer. Each time the taxpayer ‘changes the use’ of a property, it is considered to be sold at the fair market value and immediately acquired back for the same amount. The following are scenarios and steps to defer taxes for each ‘change in use’:

Residential to Rental (Complete):

If you move out of your home and start renting it, the property is deemed to be disposed of and reacquired for the fair market value. The gain that arises from the conversion may not be worrisome if it is fully sheltered by the principal residence exemption. Otherwise the capital gain would need to be reported.

Fortunately, there is an election that can be filed to avoid this ‘change in use’ deemed disposition. This election allows the gain that would otherwise be reported to be deferred until an actual disposition occurs of the property. One of the key criteria for this election is that no depreciation “capital cost allowance (CCA)” can be claimed on the property to be used against the income earned and reported on the personal tax return. An extra benefit to this election is that the property may be eligible to be claimed as the principal residence for 4 or more years after the election was made.

This election needs to be filed with the tax-return for the year the change of use occurs in.  CRA may accept a late election, but a significant penalty could apply.

Rental to Residential (Complete):

On the flip side, when the property changes from a rental to a personal use, the same type of deemed disposition would occur. Again, there is an election that can be filed to avoid the deemed disposition. This election is available if no CCA has been claimed in the past and allows you to claim the property as a principal residence for up to 4 years prior.

This election would be filed with the tax return for the year the property is actually sold, unlike the prior scenario. CRA may accept a late election, but a significant penalty could apply.

Residential to Rental (Partial):

Should you only change the use of a portion of the home, the deemed disposition will only apply to that portion of the property. However, CRA will generally not considered a personal residence to change its use if all the following conditions apply:

  • The main use of the home is as a residence and is not mainly an income producing property
  • There were no structural changes to the property
  • No CCA has been claimed on the rental portion

If these guidelines are not met, the above elections would not apply as there is only a partial change, and therefore the gain would be required to be reported. Fortunately, the 2019 federal budget proposes to allow taxpayers to file an election that would defer the gain on the disposition until the property is actually sold, to align it with the above scenarios.