Change of Use Principal Residence
It may make sense to convert your principal residence to rental property. Perhaps you are moving out and want to earn some rent; or, perhaps there is a tax advantage of changing the use the use of your principal residence. Regardless of the reason, be sure to follow the rules set out by the Canada Revenue Agency and the Canadian Income Tax Act to avoid any headaches.
The Income Tax Act (s. 45(1)(a)(i)) allows for any taxpayer to convert the use of his or her property from a personal purpose, such as converting a principal residence to a rental property. When such a change in use occurs, the taxpayer is deemed to have disposed of the personal-use property at that time for proceeds equal to its fair market value, and then reacquired it as an income-producing property at a cost equal to its fair market value. This “transaction” effectively changes the use from one purpose to another.
However, having a deemed disposition of your property can bring about tax implications that you might otherwise want to avoid. As such, the Income Tax Act (s. 45(2)) allows the Canadian taxpayer to choose if he or she wants the deemed disposition to occur. It states that the taxpayer can elect that when he or she changes the use of his or her property from a principal residence to an income-producing property, the taxpayer shall be deemed to not have begun using the property for the purpose of gaining or producing income. In other words, the Income Tax Act allows for you to file a tax election to avoid the deemed disposition even when changing the use. This results in the property continuing to be treated as the principal residence even though the use has changed. A property can qualify as a taxpayer's principal residence for up to four taxation years during which a s. 45(2) election remains in force, as long as no other property is considered your principal residence in that time span. The four year limitation on the effects of the tax election can be extended (s. 54.1) if various conditions are met when the taxpayer has to move due to the taxpayer’s or his or her spouse’s place of employment having been relocated.
If you do change the use of your principal residence, you should file the 45(2) tax election by the appropriate due date. If you file the tax election late, you could pay a penalty of $100 per month up to a maximum of $8,000, according to the tax payer relief provisions.
Changing the use of your house can be a difficult task. For example, if you improperly file a tax election, you may be subject to a penalty. However, there are also significant income tax benefits that can arise from changing the use and filing the tax election. Consequently, be sure to consult a Tax Doctors Canada income tax preparation and tax planning professional before undertaking such an endeavor. The tax professionals at Tax Doctors Canada will help you determine if switching the use of your principal residence is in your best interest; and, they will help you file a tax election to do so.
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