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 a taxpayer would be able to file an election under subsection 45(3) of the Act where the taxpayer's property was first used as a principal residence, then rented, and later became a principal residence.
Position: Yes, provided all the relevant conditions are met.
Reasons: Paragraphs (b) and (d) of the definition of principal residence in section 54 of the Act.
XXXXXXXXXX
2012-043345
A. Mahendran
November 29, 2012
Dear XXXXXXXXXX:
Re: Principal Residence Change of Use Election under Subsection 45(3) of the Income Tax Act
We are writing in reply to your correspondence of January 17, 2012, wherein you have asked us whether a taxpayer would be able to file an election under subsection 45(3) of the Income Tax Act (the "Act") where the taxpayer's property was first used as a principal residence, then rented, and later became a principal residence.
You described a situation where a taxpayer and his spouse lived in their principal residence up until 2007. In 2007, the taxpayer and his spouse moved from their principal residence because of a new employment that was not near the location of their principal residence. From 2007 to 2011, they rented out 100% of their former principal residence and earned rental income. No capital cost allowance (CCA) was ever claimed on their former principal residence, and no subsection 45(2) election was filed when the use of their property changed from principal residence to income producing in 2007. During 2011, the taxpayer and his spouse moved back to resume living in their former principal residence and ceased any rental operations. From 2007 to 2011, both the taxpayer and his spouse were residents of Canada.
Specifically, you have asked us whether the taxpayer and his spouse would be able to file a subsection 45(3) election with their 2011 tax returns and have their property qualify as a principal residence for the years 2008, 2009 and 2010.
Our Comments
Where a taxpayer starts using a property that is a principal residence for an income earning purpose, the taxpayer would normally be deemed to have disposed of and reacquired the property at fair market value under paragraph 45(1)(a) of the Act, unless an election is filed under subsection 45(2) of the Act. If the taxpayer files a subsection 45(2) election (including a late-filed election) in the tax return for the taxation year in which the change in use occurs, the taxpayer is deemed not to have commenced to use the property for an income earning purpose, with the result that the taxpayer is able to designate the property as a principal residence generally for up to four years during which the election is in effect. If the above-mentioned election is not filed and the property appreciated in value, a deemed disposition at fair market value would result in a capital gain having to be reported by the taxpayer in the year of the property's change in use.
In the situation you described, the taxpayer and his spouse (who were residents of Canada from 2007 to 2011) did not file an election under subsection 45(2) and therefore, the change in use of the property in 2007 would result in a deemed disposition and an immediate reacquisition thereafter of the property at fair market value under paragraph 45(1)(a). The taxpayer and his spouse should have reported in their 2007 tax returns the deemed disposition of their residence resulting from the change in use. As a result of not filing the no-change-in-use election available to the taxpayer under subsection 45(2), the taxpayer and his spouse are considered to have begun to use their property for the purpose of earning income in 2007 and continued until they changed its use as their principal residence in 2011.
In 2011, when the taxpayer and his spouse moved back to their former principal residence, changing its use from income producing to personal use, there would be a change in use again, and if its value had increased in the meantime, a taxable capital gain would arise from the deemed disposition of the property under paragraph 45(1)(a)(iii) of the Act. However, subsection 45(3) of the Act allows a taxpayer to elect to defer the recognition of the capital gain until an actual disposition of the property.
Pursuant to subsections 45(3) and 45(4) of the Act, an 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 where no CCA was previously claimed and allowed in respect of the property.
Since no election under subsection 45(2) was filed in 2007, pursuant to paragraph 45(1)(a), the property would be deemed to have been disposed of and reacquired immediately by the taxpayer and his spouse for the purpose of gaining or producing income in 2007. Therefore, on the change in use back to their principal residence in 2011, the taxpayer and his spouse would be able to elect under subsection 45(3) and have their property qualify as a principal residence for the years 2008, 2009 and 2010, providing all the relevant conditions are met.
We trust that the information provided is helpful.
Yours truly,
Sharmini Ratnasingham
for Director
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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