27 June 2012 External T.I. 2011-0420171E5 - Change in Use - Election under 45(3)

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: 1. Is the principal residence deduction only available on the lower floor portion of the property up to XXXXXXXXXX?
2. Would the upper floor always be considered a taxable property, if the taxpayer disposed of the property in 2011?

Position: 1. Yes
2. Yes

Reasons: 1. The lower floor was ordinarily inhabited and used by the taxpayer as his/her principal residence up to XXXXXXXXXX.
2. The upper floor has never been inhabited by the taxpayer and always been used to earn rental income.

XXXXXXXXXX
			2011-042017
			A. Mahendran

June 27, 2012

Dear Mr. XXXXXXXXXX:

Re: Principal Residence – Change of Use

We are writing in reply to your correspondence of September 8, 2011, wherein you requested our views on the application of the deemed disposition rules provided under paragraph 45(1)(c) of the Income Tax Act (ITA) where there are changes in the pattern of occupancy of a principal residence by a taxpayer.

You described a situation where a taxpayer acquired a residential property in XXXXXXXXXX. The upper floor (XXXXXXXXXX% of total area) of the property was rented right away and the lower floor (XXXXXXXXXX% of total area) of the property was inhabited by the taxpayer from XXXXXXXXXX to mid XXXXXXXXXX. In mid XXXXXXXXXX, there was a change in use and the taxpayer rented out both the upper floor and the lower floor of the property. The taxpayer is contemplating the sale of the property in XXXXXXXXXX.

You have asked for our views as to whether the principal residence deduction is only available on the lower floor portion of the property up to XXXXXXXXXX and whether the upper floor was always considered a taxable property, if the taxpayer disposed of the property in XXXXXXXXXX.

Our Comments:

If a property in Canada qualifies as a taxpayer's "principal residence", the taxpayer can use the principal residence exemption provided in paragraph 40(2)(b) of the Act to reduce or eliminate any capital gain otherwise occurring for income tax purposes on the disposition (or deemed disposition). The term "principal residence" is defined in section 54 of the Act.

The definition of “principal residence” in section 54 of the ITA specifies that a housing unit must be owned by a taxpayer and ordinarily inhabited in the year by the taxpayer or the taxpayer’s spouse or common-law partner, former spouse or common-law partner, or by a child of the taxpayer in order to qualify as the taxpayer’s principal residence.

Where an individual lives in lower floor portion of a property and the upper floor is rented out from the date of acquisition of the property, it is our view that the “ordinarily inhabited” requirement would not be satisfied in respect of the rented portion of the property.

Based on the given facts, it appears that the upper floor portion of the property has never been “ordinarily inhabited” by the taxpayer for purposes of the definition of “principal residence” in section 54 of the ITA and therefore, it will not be considered as taxpayer’s principal residence for any taxation year. Accordingly, the principal residence deduction will not be available on the upper floor portion of the property for any taxation year.

Furthermore, paragraph 19 of IT-120R6 provides that when the whole property is sold after the partial change in use, any capital gain relating to the income-producing portion of the property will be realized and taxable in accordance with the usual rules respecting the disposition of capital property.

Based on the above analysis, if the taxpayer disposes of the property in XXXXXXXXXX, the gain on the disposition of the upper floor would not qualify for the principal residence exemption provided under paragraph 40(2)(b) of the Act.

You have also asked whether the taxpayer could file an election under subsection 45(3) of the Act to defer the recognition of the change in use if, instead of disposing of the property in XXXXXXXXXX, the taxpayer moved into the upper floor in XXXXXXXXXX to reside.

The above noted election is only available in a case where the property was used solely for the purpose of earning income and then ceased to be used for that purpose to become a taxpayer’s principal residence. Paragraph 30 of IT-120R6 clearly states that the election under subsection 45(3) cannot be made where there is a partial change in use of a property.

If the taxpayer moved into the upper floor, there could be a potential increase in the portion of the property used for personal purposes, probably from 0% (XXXXXXXXXX) to 60% (XXXXXXXXXX). This would trigger a deemed disposition, under clause 45(1)(c)(i)(A) of the Act, of the portion of the property now used for personal purposes.

We trust that the information provided is helpful.

Yours truly,

Sharmini Ratnasingham
Assistant Director
Financial Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch