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What Happens When I Move Into a Rental Property?

The Scenario

Geoff and Maria own three prop­er­ties:

  1. A home in Toronto that they cur­rently live in
  2. A home in Waterloo that they rent out as an in­come prop­erty
  3. 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:

  1. Convert their Toronto home into a rental prop­erty
  2. 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:

  1. You change part of, or all, your prin­ci­pal res­i­dence into a rental prop­erty
  2. You move into a rental prop­erty and use it as your prin­ci­pal res­i­dence
  3. 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:

  1. 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
  2. S3 — They must re­port the sale on sched­ule 3 of their T1 in the year of ac­tual dis­po­si­tion.
  3. 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.

Next steps

Are you frus­trated with the level of tax you’re pay­ing? Do you feel like tax ad­vi­sors and fi­nan­cial ad­vi­sors aren’t speak­ing the same lan­guage? Are you of­ten left won­der­ing if you are leav­ing money on the table due to a lack of in­te­grated plan­ning?

Fabio and his team have been help­ing clients plan their tax, re­tire­ment, and es­tate mat­ters since 2002.

If you’re in­ter­ested in tak­ing con­trol of your fi­nan­cial mat­ters, then don’t hes­i­tate to con­tact us di­rectly for an ini­tial con­ver­sa­tion.

No cost, no oblig­a­tions.


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