- 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If CCA is claimed on the property, the election is considered rescinded on the ﬁrst day of the year in which that claim is made.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:
- 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.
- 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.
- 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.
- 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:
- 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:
- $8,000 or
- $100 for each complete month from the original due date the amendment request was made to CRA
- 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.
- 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.
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