What Happens When I Convert my Principal Residence into a Rental Property?

The Scenario:

• Lenny and Lynn have lived in their cur­rent home in Toronto, ON for 5 years. They bought it for $1,000,000 and it is cur­rently worth about $1,300,000.
• The cou­ple needs to move from Toronto to Vancouver to ex­pand their busi­ness
• They are un­sure if the move will be per­ma­nent or tem­po­rary
• They de­cide to rent out their cur­rent prin­ci­pal res­i­dence to cover their cash-flow and rent a condo in Vancouver to live in

What hap­pens from a tax per­spec­tive, and do they lose the prin­ci­pal res­i­dence ex­emp­tion on the prop­erty?

Outlining the tax law:

Since Lenny and Lynn com­pletely con­verted their prin­ci­pal res­i­dence to an in­come-pro­duc­ing prop­erty, they are deemed by ITA para­graph 45(1)(a) to have dis­posed of the prop­erty (both land and build­ing) at fair mar­ket value and reac­quired it im­me­di­ately there­after at the same amount.

This will re­quire the fil­ing of form T2091 – Designation of a Property as a Principal Residence by an Individual on their T1s in the year of the deemed dis­po­si­tion.

Any gain de­ter­mined on this deemed dis­po­si­tion may be elim­i­nated or re­duced by the prin­ci­pal res­i­dence ex­emp­tion.

The cou­ple may choose to de­fer recog­ni­tion of any gain to a later year by elect­ing un­der sub­sec­tion 45(2) to be deemed not to have made the change in use of the prop­erty.

This elec­tion is made by writ­ing a let­ter to the CRA elect­ing un­der ITA 45(2) and send­ing it in with the in­come tax re­turn for the year in which the change in use oc­curred.

If Lenny and Lynn re­scind the elec­tion in a sub­se­quent tax year, they are deemed to have dis­posed of and reac­quired the prop­erty at fair mar­ket value on the first day of that sub­se­quent year.

If CCA is claimed on the prop­erty, the elec­tion is con­sid­ered re­scinded on the first day of the year in which that claim is made.

Tax plan­ning op­por­tu­ni­ties:

Their prop­erty can qual­ify as their prin­ci­pal res­i­dence for up to four tax years dur­ing which a sub­sec­tion 45(2) elec­tion re­mains in force, even if the hous­ing unit is not or­di­nar­ily in­hab­ited dur­ing those years by the cou­ple.

However, they must be res­i­dent, or deemed to be res­i­dent, in Canada dur­ing those years for the full ben­e­fit of the prin­ci­pal res­i­dence ex­emp­tion to ap­ply, and they may only des­ig­nate one prop­erty as their prin­ci­pal res­i­dence dur­ing those years.

In this cou­ple’s sit­u­a­tion it is ben­e­fi­cial to make the elec­tion as the ex­ten­sion of the prin­ci­pal res­i­dence elec­tion could lead to sig­nif­i­cant tax sav­ings over the next four years should the prop­erty mar­ket in Toronto con­tinue to climb.

Watch out for the tax traps!

It is im­por­tant for the cou­ple to en­sure they have made all the nec­es­sary fil­ings re­lated to this change in use in­clud­ing:

1. T2091 — Designation of a Property as a Principal Residence by an Individual — filed with their T1 and due on April 30 of the sub­se­quent year or June 15 if ei­ther Lenny or Lynn are self-em­ployed in the year of a deemed dis­po­si­tion or, if a 45 (2) elec­tion is made, in the year of ac­tual dis­po­si­tion.
2. 45(2) Election let­ter — A phys­i­cal let­ter that must be sent to the CRA out­lin­ing the de­tails of the elec­tion — Due at the same time as the cou­ple’s T1 re­turn in the year they wish to make the elec­tion.
3. S3 — They must re­port the deemed dis­po­si­tion of the prop­erty on Schedule 3 of their T1 in the year of a deemed dis­po­si­tion or, if a 45 (2) elec­tion is made, in the year of ac­tual dis­po­si­tion.
4. T776 — Statement of Real Estate Rentals — Reporting the rental in­come and ex­penses re­lated to the prop­erty in the year that the ten­ant was placed in the prop­erty and each sub­se­quent year that the prop­erty is rented

Important traps to watch out for:

1. Late fil­ing penalty for T2091 or 45(2) elec­tion — This penalty can be sig­nif­i­cant and the fil­ing of the T2091 or the 45(2) elec­tion should not be over­looked. The penalty is the lesser of:
   1. $8,000 or
   2. $100 for each com­plete month from the orig­i­nal due date the amend­ment re­quest was made to CRA
2. 45(2) late fil­ing elec­tion ac­cep­tance is at the dis­cre­tion of the CRA and the CRA is not ob­lig­ated to ac­cept it. For ex­am­ple, if you have mul­ti­ple prop­er­ties, the CRA may deny a late-filed elec­tion as it could be con­strued as retroac­tive tax plan­ning.
3. DO NOT take CCA — CCA (Capital Cost Allowance) pro­vides real es­tate in­vestors with the abil­ity to de­fer tax­able in­come on their rental earn­ings and can be a crit­i­cal tax plan­ning tool. However, the 45(2) elec­tion is con­sid­ered re­scinded on the first day of the year in which the CCA claim is made.

At the Campanella Group we help clients like the Lenny and Lynn every day. We are ded­i­cated to help­ing our clients forge the best finan­cial path for their fam­i­lies by care­fully in­te­grat­ing their tax, in­vest­ment, and es­tate plans.

Are you ready to take a step for­ward and se­cure a lu­cra­tive finan­cial fu­ture for your­self and your fam­ily? We are al­ways ready to speak to am­bi­tious en­tre­pre­neurs and high-in­come earn­ing fam­i­lies look­ing for an edge.

Feel free to con­tact us for a zero-cost, 30-minute, on­line meet­ing where we can get to know you and de­ter­mine if we can help you pave a path to finan­cial suc­cess.