Converting a principal residence into a rental property is generally a change in use. Without a special rule, the owner may be deemed to have sold the property at fair market value at the time of the change and immediately reacquired it. A subsection 45(2) election can, in some situations, defer that deemed disposition.
The election does not automatically shelter the entire rental period under the principal residence exemption. It changes the timing of the disposition and may allow the property to continue to be designated for certain years, subject to the conditions.
Document the change in use and the property value
Establish the date on which the property ceased to be used primarily as a home and began to earn income. A fair market value appraisal is important even if a 45(2) election is planned because the value may be needed if the election is invalid or another change occurs later.
Keep the cost of improvements, acquisition expenses and prior designation history. A partial, temporary or incidental rental may require a different analysis from a full conversion of the property.
File the 45(2) election correctly
The election is generally made by a letter filed with the return for the year of the change in use. There is no single prescribed form that replaces an explanation of the facts. A late election may sometimes be requested, but acceptance is discretionary and a penalty may apply.
The owner generally should not claim capital cost allowance on the property while relying on the election. A CCA claim can defeat the intended treatment and trigger the deemed disposition.
Understand the principal residence designation
Subject to the conditions, the property may continue to be designated as a principal residence for up to four rental years. A longer period may be available in certain employment-relocation situations. The taxpayer must remain a Canadian resident for the relevant years and satisfy the other requirements.
A family can generally designate only one property as its principal residence for a particular year. Continuing to designate the former home may therefore prevent a full designation of the new home. The expected growth of both properties should be compared.
- Value at the change in use supported by market evidence.
- Election letter retained with proof of filing.
- No CCA claim if the election is to remain effective.
- Designation years coordinated with other family residences.
Report rental income while the election is in effect
The election does not eliminate the obligation to report rent and expenses. The owner prepares the rental statement, distinguishes current costs from capital expenditures and retains invoices. Renting to a relative below fair market value may also limit a rental loss.
Quebec treatment and supporting documents should be coordinated with the federal return. See our personal tax and tax planning services.
Decide before claiming CCA
A 45(2) election should be reviewed in the first rental year, before returns and CCA claims establish a treatment that is difficult to reverse. Value, expected rental duration and the possible purchase of another home are all important.
Impôts Ici can compare the scenarios, prepare the election letter and include the rental income in the returns. To review a change in use, contact our team.
