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: Whether the operation of a bed and breakfast affects the taxpayer's claim of the principal residence exemption.
Position: None taken.
Reasons: General comments. IT-120R6.
XXXXXXXXXX 2011-042105
Tim Fitzgerald, CGA
December 8, 2011
Dear XXXXXXXXXX :
Re: Principal Residence and a Bed and Breakfast ("B &B") operation
We are replying to your correspondence of September 13, 2011, concerning the principal residence exemption in paragraph 40(2)(b) of the Income Tax Act (Canada) (the "Act").
In your correspondence, you describe several scenarios centering on a situation where a couple purchased a property for use as their principal residence but shortly thereafter began operating a B&B out of a portion of the property after making certain renovations. Your concern relates to the income tax implications when the couple commences and/or ceases their B&B operation and, as well, when the couple eventually sells the property.
Specifically, you would like to know whether it makes any difference, in terms of being able to claim the principal residence exemption, if, at the time the couple purchased the property, the initial intention was to use the entire property as a principal residence but, subsequently the couple decided to use a portion of the property for the B&B operation. You also wanted to know if the ability to claim the principal residence exemption is jeopardized if capital cost allowance ("CCA") is claimed on the portion of the property that was used in the B&B operation.
Our Comments
The situation described in your correspondence would appear to concern specific taxpayers involving completed transactions and the scenarios you described seem to be in the nature of tax planning. The Canada Revenue Agency ("CRA") does not offer tax planning advice. However, the following general comments may be of assistance.
The income tax rules regarding the principal residence, including the principal residence exemption, are discussed in the CRA's Interpretation Bulletin IT-120R6 - Principal residence. With regard to the renovations you mentioned, we would also mention that Interpretation Bulletin, IT-128R, Capital Cost Allowance - Depreciable Property, discusses some factors to consider in determining whether a particular expenditure is capital in nature or may otherwise be deductible as general repairs or maintenance.
Generally, if a property qualifies as a taxpayer's principal residence, the taxpayer can use the principal residence exemption to reduce or eliminate any capital gain otherwise occurring, for income tax purposes, on the disposition (or deemed disposition) of the property. The term "principal residence" is defined in section 54 of the Act. The principal residence exemption is claimed under paragraph 40(2)(b) of the Act, or under paragraph 40(2)(c) where land used in a farming business carried on by the taxpayer includes the taxpayer's principal residence.
If a taxpayer has partially converted a principal residence to an income-producing use, paragraph 45(1)(c) of the Act provides for a deemed disposition of the portion of the property so converted (such portion is usually calculated on the basis of the area involved) for proceeds equal to its proportionate share of the property's fair market value ("FMV"). Paragraph 45(1)(c) of the Act also provides for a deemed reacquisition immediately thereafter of the same portion of the property at a cost equal to the same amount. If the portion of the property so changed is later converted back to use as part of the principal residence, there is a second deemed disposition (and reacquisition) thereof at FMV.
However, the above change-in-use rules are not applied by the CRA in respect of a principal residence provided that certain conditions are met. As indicated in paragraph 32 of IT-120R6, it is the CRA's practice not to apply the deemed disposition rule, but rather to consider that the property retains its nature as a principal residence, where all of the following conditions are met:
(a) the income-producing use is ancillary to the main use of the property as a residence,
(b) there is no structural change to the property, and
(c) no CCA is claimed on the property.
Whether a property is being used by a taxpayer as the taxpayer's principal residence and/or whether use of a portion of the property as a B&B operation is ancillary to the main use of the property as the taxpayer's principal residence are ultimately questions of fact. In respect of a completed transaction, such matters would be dealt with by the particular taxpayer's tax services office ("TSO") during the course of their review/examination of the taxpayer's income tax return for the particular taxation year.
We would also mention that subsection 18(12) of the Act would generally apply in computing income from a B&B operation. Pursuant to subsection 18(12), a taxpayer would generally only be able to deduct amounts such as heating and lighting, property taxes, and other house-related expenses to the extent of the taxpayer's income from the business. Further information concerning the application of this provision of the Act is provided in Interpretation Bulletin, IT-514, Workspace in home expenses.
The interpretation bulletins referred to in this letter are available on the CRA's website.
We trust that these comments will be of assistance.
Yours truly,
Michael Cooke, C.A.,
Manager
Capital Transactions Section
Business and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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