Geoff and Maria own three properties:
- A home in Toronto that they currently live in
- A home in Waterloo that they rent out as an income property
- A cottage north of Toronto that they only use personally
Geoff was recently offered his dream job in Waterloo and the couple decided to move. Lucky for them, their long-term tenants in Waterloo are vacating their income property within a month.
They’d like to:
- Convert their Toronto home into a rental property
- Move into their former income property in Waterloo
They want to know the tax consequences of these actions.
If you’re interested in scenario 1, converting a principal residence into a rental property CLICK HERE.
This blog post outlines the tax consequences of scenario 2: Moving into an income producing property.
Outlining the Tax Law: Change in use
When you change the use of a property you are considered to have sold the property at Fair Market Value (FMV) and reacquired it for tax purposes. This is the case whether you sold the property or not. In tax, we refer to this as a “deemed disposition”. (ITA 45 (1))
This is the case when:
- You change part of, or all, your principal residence into a rental property
- You move into a rental property and use it as your principal residence
- You stop using a property to generate or produce income
The deemed disposition and immediate reacquisition will often result in a capital gain or loss that must be reported on your tax return.
Therefore, pursuant to section 45 (1) of the Income Tax Act (ITA), Geoff and Maria have a problem…
Both their principal residence and their rental property have appreciated in value since they were purchased.
The deemed disposition of their principal residence should be tax-free as there is no tax payable on the sale or disposition of a principal residence in Canada.
However, the deemed disposition of their rental property is NOT tax-free.
Tax Planning Opportunities:
Lucky for Geoff and Maria they have an option. This option is found in section 45 (3) of the ITA: “Election concerning principal residence”.
Pursuant to this section of the ITA, Geoff and Maria can elect to postpone reporting the disposition of their property until they actually sell it.
This is a very useful election as it allows them to avoid what would be a large tax bill leading to a cash-ﬂow issue for them.
In fact, should it be beneﬁcial, the principal residence exemption can be carried back up to 4 years that the property was rented out.
Watch out for the tax traps!
A section 45 (3) election can not be made if the couple deducted CCA (depreciation) on the property for any tax year after 1984, and on or before the day they change its use.
This is an important point as it is very common for CCA to be taken to defer rental income, especially for high income earning families. Care must be taken when electing to take CCA. If you feel you may want to move into one of your rental properties, you may want to reconsider CCA.
When the couple sells the property, they must ﬁle:
- 45 (3) election letter — This letter must be ﬁled along with their tax return (T1) in the year of actual disposition and must outline their desire to elect under ITA 45 (3) along with outlining the details of the property
- S3 — They must report the sale on schedule 3 of their T1 in the year of actual disposition.
- T2091 — “Designation of a Property as a Principal Residence by an Individual” must be ﬁled outlining the details of their principal residence allocation to the property in the year of actual disposition.
Important traps to watch out for:
- Late ﬁling penalty for T2091 or 45(3) election — This penalty can be significant. The penalty is the lesser of:
- $8,000 or
- $100 for each month from the original due date the amendment request was made to the CRA
At the Campanella Group we help clients like the Geoff and Maria 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.