Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Taxpayer owns a rental property. His daughter moves in. Taxpayer receives monthly payments from his daughter for ten months then sells the property to her. Taxpayer's intention from the start has been to treat the monthly payments received from his daughter as deposits towards her down payment on the property.
1. Whether taxpayer may continue to deduct property taxes, insurance costs, maintenance, and interest expenses after his daughter moved in up until the time it is sold to his daughter.
2. Whether the taxpayer's POD from the eventual sale of the property will include the sum of the monthly payments he received from his daughter, which he treated as deposits towards the down payment for the property.
Position: 1. Depends. 2. Yes.
Reasons: 1. It is a question of fact whether the monthly payments received by the taxpayer from his daughter constitute rental income or refundable deposits held by the taxpayer to be applied in the future against the purchase price of the property. If in fact the monthly payments received by the taxpayer are non-refundable in the event that the sale does not transpire then the amounts received by the taxpayer will likely be considered rental income. In that case, any related outlays or expenses incurred by the taxpayer to earn rental income from the property would be deductible. Conversely, as a question of fact, if the daughter is living rent-free such that the amounts received by the taxpayer are in fact refundable deposits then the taxpayer's outlay and expenditures relating to the property would be personal expenses and would be non-deductible by virtue of paragraph 18(1)(a) of the Act. 2. Regardless of how the daughter's down payment is financed, be it by way of a gift from the taxpayer inter vivos or otherwise, the entire down payment forms part of the sale price and would be fully included in the taxpayer's POD.
Tim Fitzgerald, CGA
October 22, 2007
Re: Disposition of Rental Property
This is further to your letter of March 23, 2007 wherein you requested our views in respect of a disposition of rental property.
In the situation you describe, you own rental property that you intend to sell to your daughter. Your daughter does not have sufficient funds for a down payment. Your daughter took up residence at the property on January 1, 2007. In what you describe as a "rent to own" arrangement, our understanding is that you receive monthly payments from your daughter, which you hold on deposit towards her eventual down payment on the property. You expect that by the fall of 2007, the sum of monthly payments received will be sufficient to cover her down payment and your daughter will finance the rest of the purchase price by means of a mortgage from a bank. In the meantime, you have retained full title to the property and you continue to pay mortgage interest, property taxes, insurance costs and maintenance costs in respect of the property.
You would like to know whether for tax purposes you must report as rental income the monthly payments you have received from your daughter since the time that she took up residence on the property or alternatively, whether the monthly payments can be treated as deposits towards your daughter's cost of the property and as such would be included in your proceeds of disposition when you eventually sell the property to your daughter. Secondly, in respect of the period commencing at the time your daughter took up residence on the property up until such time that you actually sell the property to her, you would like to know whether you may continue to claim expenses incurred in respect of the property such as mortgage interest, property taxes, insurance costs and repairs and maintenance expenses, etc.
As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. The particular situation outlined in your letter appears to be a factual one, involving specific taxpayers and completed transactions. Accordingly, you should submit all relevant facts and documentation to the appropriate tax services office for their views. However, we offer the following general comments, which we trust will be of assistance.
In order to determine whether the expenses you incur in respect of the property are deductible for tax purposes and whether your daughter's monthly payments constitute rental income or a deposit toward the purchase cost of property, it would be necessary to determine the date on which the property is sold to your daughter. The basic rule is that property in respect of specific assets is sold at the time when the parties to the contract intend ownership of the property to pass from the vendor to the purchaser, as evidenced by the terms of the contract, the conduct of the parties and any other circumstances that may be relevant. However, if there is a conditional contract of sale, the relevant date is normally when all the conditions have been satisfied. Paragraphs 17, 18 and 19 of IT-285R2, Capital Cost Allowance - General Comments, have additional information on this subject.
The "rent to own" arrangement you have described appears to be a conditional contract of sale because your daughter must first raise sufficient funds for the down payment in order to transact the sale. Therefore it is our view that the property will likely be disposed of as of the date this contingency is met and you and your daughter enter into an irrevocable contract of sale. Since determining the time of sale is ultimately a question of law that can only be resolved by examining the actual terms of the contract, you may wish to obtain professional advice if you need assistance in establishing the date of sale.
With regard to the monthly payments you receive from your daughter, it is a question of fact whether and to what extent the amounts received are rent for the use of the property or alternatively, refundable advance deposits held by you for future application towards your daughter's purchase price of the property. Such a question can only be resolved on the basis of the facts taking into account the agreement between you and your daughter and what was intended by each of you. If your daughter's monthly payments are intended as payments for her right to use the property, are non-refundable, and represent the fair market rent for the property, they would likely be considered rental income (i.e., your property continues to be a rental property) and, in that case, your expenses incurred for the purpose of earning the rental income would generally be deductible for the purpose of computing income for tax purposes.
On the other hand, if your daughter's monthly payments are not for the right to use the property (i.e., rent) but are in fact refundable deposits (i.e., forced savings) to be used towards the purchase cost of the property, then they are not rental income and the expenses you incur in respect of the property are not deductible for tax purposes. Under this scenario, your daughter is effectively living rent-free and the monthly payments will be applied towards the purchase price of the property at the time the actual sale occurs. In this scenario, the property ceased to be a rental property and became a personal-use property when your daughter started residing in it, and accordingly, your expenses in respect of the property such as property taxes etc. would be personal in nature and would be non-deductible for income tax purposes.
The comments that follow below pertain to the situation where the property ceased to be a rental property and became a personal-use property when your daughter commenced to reside in it (i.e., the monthly payments are not rental income but are forced savings).
Except where an election is made under subsection 45(3) of the Act, there is a deemed disposition rule in subsection 45(1) of the Act when there is a change in use of a property. The rule is that where a taxpayer has acquired capital property for the purpose of gaining or producing income and has commenced at a later time to use it for personal purposes, the taxpayer is deemed to have disposed of the property at that later time for proceeds equal to its fair market value and to have immediately thereafter reacquired it at a cost equal to that fair market value. If the property appreciated in value, a capital gain will arise from the deemed disposition and will have to be reported for tax purposes in the year of change in use. Another tax provision, paragraph 13(7)(a) of the Act, contains a similar deemed disposition rule on a change in use of depreciable property that may result in the recapture of capital cost allowance (CCA), if it had been deducted in previous taxation years in respect to the property.
However, there is an exception to the above deemed disposition rule regarding capital gains that would allow a taxpayer to elect to defer the recognition of a disposition (and the reporting of any related capital gain) until the property is actually disposed of, provided certain conditions are met. Pursuant to subsection 45(3), an election may be made which will nullify the deemed disposition under subsection 45(1) mentioned above. This election can only be made where a capital property that was acquired by a taxpayer for the purpose of gaining or producing income ceases to be used for that purpose and becomes the "principal residence" of the taxpayer and, as well, where no CCA was previously claimed and allowed in respect of the property.
It is a question of fact whether or not a particular property is a "principal residence" of a taxpayer for income tax purposes. "Principal residence" is defined in section 54 of the Act and is discussed in Interpretation Bulletin IT-120R6, which is available on the Canada Revenue Agency's website at http://www.cra-arc.gc.ca. A property can be a taxpayer's principal residence if it meets certain conditions. One of the conditions to be met is that the property must ordinarily be inhabited by the taxpayer, the taxpayer's spouse or common-law partner, or the taxpayer's child (of any age), and must be designated as a principal residence.
However, we would mention that, as more fully explained in paragraph 6 of IT-120R6, after 1981 only one property can be designated as a principal residence by a taxpayer for a particular year and no other property can be so designated for the year by the taxpayer or a member of the taxpayer's family unit. For the purpose of the designation, a taxpayer's family unit would generally include the taxpayer, the taxpayer's spouse or common-law partner, and the taxpayer's children (unmarried and not living in a common-law partnership) less than 18 years of age.
Accordingly, assuming no CCA was claimed on your rental property prior to its change in use, an election under subsection 45(3) of the Act is only available to you where the property in question does in fact become your "principal residence" by virtue of being ordinarily inhabited and designated as such and where no other property has been designated as a principal residence in the years in question by you or a member of your family unit.
While we trust our comments are of assistance, they are not intended to be exhaustive. More information can be found in the following CRA publications, Guide T4036 - Rental Income and Guide T4037 - Capital Gains, which can be viewed on our web-site, http://www.cra-arc.gc.ca. As previously indicated, given that your situation involves specific taxpayers and completed transactions, you may wish to submit all relevant facts, details and documentation to your local tax services office for their views.
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch
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