27 June 2024 External T.I. 2023-1000391E5 - BC Secondary Suite Incentive Program

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: Various questions concerning the income tax implications to a homeowner that participates in the new BC Secondary Suite Incentive Program.

Position: General comments provided.

Reasons: See below.

XXXXXXXXXX							2023-100039
								Christina Foggia, CPA CA

June 27, 2024

Dear XXXXXXXXXX:

Re: BC Secondary Suite Incentive Program –Income Tax Implications to Homeowners

This is in reply to your correspondence of November 30th, 2023, wherein you requested our views concerning the potential income tax implications to a homeowner who participates in and receives financial assistance under the BC Secondary Suite Incentive Program (“BC SSIP” or the “Program”), a program administered by the BC Ministry of Housing (“BC Housing”).

Background and Facts

We understand that the BC SSIP aims to add new affordable rental units to the existing housing supply by providing financial assistance to qualifying homeowners (referred to as “Homeowners”) who create a new secondary suite or accessory dwelling unit (collectively referred to as a “Secondary Suite”) on the property of their principal residence (“Property”). The financial assistance is provided by way of a forgivable loan in the amount of 50% of the construction costs of a Secondary Suite up to a maximum loan amount of $40,000 plus $2,000 of legal costs that BC Housing is expected to incur (referred to herein as the “SSIP Loan” or the “Loan”). (footnote 1)

The SSIP Loan will be registered on title of the Homeowner’s Property for five years and interest will accrue on the Loan based on the current prime rate of interest charged by the Royal Bank of Canada plus 2.0%. For the SSIP Loan (plus accrued interest) to be forgiven under the Program, the Secondary Suite must be rented at below market rates (that is, a rate that does not exceed the rent affordability limit (“RAL”)) (footnote 2) for at least five years. The Loan (plus accrued interest) will be forgiven over five years at a rate of 20% per year if all of the Program requirements are satisfied. Homeowners that do not comply with the terms and conditions of the Program are required to repay the outstanding principal balance of the Loan and any interest that has accrued to BC Housing on demand. (footnote 3)

To be eligible for the Program, the Property must be located in an eligible community in British Columbia and must be the principal residence of all owners registered on title. In addition, the Secondary Suite must be a newly constructed legal self-contained unit with a kitchen, bedroom, and full bathroom facilities located within or detached from the Homeowner’s principal residence, and includes secondary suites attached to the primary residence (for instance, basement suites and garage suites), as well as detached secondary suites (such as, laneway homes, garden suites and garage suites). (footnote 4) Costs in respect of the betterment of existing rental units do not qualify for funding under the Program.

As described in your correspondence, among other requirements, to participate in the Program, a Homeowner must apply and be accepted, must enter into a tenancy agreement with a tenant who is not their immediate family member (that is, not their spouse, child, parent or sibling) (“Qualifying Tenant”), and must comply with the Residential Tenancy Act. Note that certain other eligibility criteria must be met by a Homeowner to qualify.

After the five-year period is complete, we understand that Homeowners must continue to follow their obligations under the Residential Tenancy Act, however, they are permitted to apply annual rent increases to existing tenants based on the maximum allowable increase posted by the Residential Tenancy Branch each year. As well, after the SSIP Loan has been fully forgiven, there is no restriction on what rent can be charged when entering into a rental agreement with a new tenant, consistent with the Residential Tenancy Act. (footnote 5)

Questions

1. Is the rent received by a Homeowner under the Program considered a source of rental income?

• Is a Homeowner required to report rental income at the fair market value (“FMV”), or the actual amount of rent received under the Tenancy Agreement?
• If a Homeowner incurs rental losses in an arm’s-length rental arrangement, will the CRA deny these losses on the basis that the rental activity is not a source of income?

2. Is the amount of the SSIP Loan that is forgiven under the Program income to the recipient Homeowner under paragraph 12(1)(x) of the Income Tax Act (“Act”)?

• If yes, is the amount required to be reported in the Homeowner’s income in the year of issuance or in the year of forgiveness?
• Does BC Housing have any reporting requirements under Part II of the Income Tax Regulations (“Regulations”)?

3. Is there a deemed disposition of the Secondary Suite pursuant to subparagraph 45(1)(c)(ii) of the Act by changing the use of part of the Property from personal-use to an income-producing use?

4. If a deemed disposition pursuant to subparagraph 45(1)(c)(ii) of the Act occurs, can the taxpayer elect under subsection 45(2) of the Act such that a disposition will be deemed not to have occurred, assuming that the Homeowner does not claim capital cost allowance (“CCA”) on the Secondary Suite?

5. Can a Homeowner claim the principal residence exemption (“PRE”) pursuant to paragraph 40(2)(b) of the Act for the entire Property (that is, both the portion they occupy and the Secondary Suite) when they dispose of it, for the years that they used the Secondary Suite for rental use?

Our Comments

This technical interpretation provides general comments about the provisions of the Act and the Regulations. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

1. Is the rent received by a Homeowner under the Program considered a source of rental income?

Generally, an amount is taxable under the Act if it constitutes income from a source under section 3 of the Act, such as income from a business or property, or if a specific provision of the Act applies. If the income does not fall within one of these sources of income, it is generally not taxable. In accordance with the Supreme Court of Canada decision of Stewart vs. the Queen (2002 SCC 46), a particular activity will generally constitute a source of income from business or property for purposes of the Act where it is undertaken in pursuit of profit and is not a personal endeavour. Where a personal or hobby element to the taxpayer’s activity exists, the activity will be considered a source of income from business or property only if the activity is undertaken in a sufficiently commercial manner.

While it is a question of fact in each situation, in our view, the fact that a Homeowner has to adhere to various BC SSIP requirements, such as building a full, legal Secondary Suite and renting it for five years to a qualifying tenant who cannot be an immediate family member, could support a determination that a Homeowner’s rental activities under the Program are commercial in nature (that is, not a personal endeavour) and that they are undertaking the activity with an intention to profit, thereby constituting a source of income under the Act. Furthermore, where a source of income is determined to exist for purposes of the Act, in our view that source will be from property, since the type of rental arrangement contemplated under the Program is a long-term rental arrangement under the conditions noted above.

As noted, pursuant to the terms of the Program, a Homeowner can only charge, and a Qualifying Tenant is only required to pay, rent not to exceed the applicable RAL amount (that is, below market rent). Therefore, it is our view that for each taxation year that a Homeowner participates in the Program, they would only be required to include in their income the actual amount of rent received pursuant to the tenancy agreement rather than an amount corresponding to FMV rent. (footnote 6)

Finally, provided that a Homeowner’s rental activity is considered a source of income under the Act, it is our view that, if rental losses are incurred, the rental losses should not be denied. Information about allowable expenses for rental property and limitations on CCA can be found in T4036 Rental Income guide. (footnote 7)

2. Is the amount of the SSIP Loan that is forgiven under the Program income to the recipient Homeowner under paragraph 12(1)(x) of the Act?

To the extent a government is not making an ordinary commercial investment in respect of contributions or a loan it makes to a taxpayer, the government would generally be considered to be providing the taxpayer with government assistance. As such, in the circumstances of the BC SSIP, the forgivable SSIP Loan provided to a Homeowner by the BC Housing would in our view, constitute government assistance.

When government assistance is received in the course of earning income from a business or property, the application of well-accepted business principles for the purpose of calculating profit (or loss) under section 9 of the Act commonly require that the cost of the asset or the amount of the expense to which the assistance relates be reduced accordingly. Alternatively, where the government assistance is not related to an expense or asset, these principles require that the amount will generally be included in the recipients business or property income. If such well-accepted business principles do not apply, there are specific provisions in the Act that require the recipient to include the government assistance in business or property income [paragraph 12(1)(x)] or where appropriate, reduce the capital cost [subsection 13(7.1)] or adjusted cost base [paragraph 53(2)(k)] of the property to which the assistance relates.

Specifically, as noted in paragraphs 4 and 5 of Interpretation Bulletin IT-273R2, Government Assistance – General Comments, (footnote 8) generally, when a taxpayer receives or is entitled to receive government assistance for the acquisition of depreciable property (before the disposition of the property), subsection 13(7.1) of the Act applies to reduce the capital cost of the property by the amount of the assistance. Similarly, when a taxpayer receives or is entitled to receive government assistance in respect of non-depreciable capital property (before the disposition of the property), paragraph 53(2)(k) of the Act applies to reduce the adjusted cost base of the property by the amount of the assistance.

In the situation under consideration, it is our view that either subsection 13(7.1) or paragraph 53(2)(k) will generally apply to reduce the cost of the property, such that any amount that would otherwise be required to be included in a Homeowner’s income because of paragraph 12(1)(x) will be reduced by means of subparagraph 12(1)(x)(vi). Furthermore, the timing of a reduction to the adjusted cost base or capital cost of the property is in the year that the loan is received by a Homeowner.

Part II of the Regulations imposes an obligation on persons who make certain payments to file information returns. These provisions can apply to a wide variety of payments, including certain forms of government assistance. As the SSIP Loan amounts are generally not amounts that are described in Part II of the Regulations, it is our view that BC Housing does not have any information return reporting requirements in regard to these amounts.

3. Is there a deemed disposition of the Secondary Suite pursuant to subparagraph 45(1)(c)(ii) of the Act by changing the use of part of the Property from personal-use to an income-producing use?

Where a taxpayer has partially converted their principal residence to an income-producing use, subparagraph 45(1)(c)(ii) of the Act deems a disposition (and reacquisition) of that part of the property to have taken place (such portion is usually calculated on the basis of the area involved) for proceeds equal to its proportionate share of the property’s FMV. Any gain otherwise determined on the deemed disposition may be eliminated or reduced by the PRE. However, paragraph 2.59 of Income Tax Folio S1-F3-C2 “Principal Residence” (“PR Folio”), (footnote 9) explains that the CRA’s practice is not to apply the deemed disposition rule, but rather to consider that the entire property retains its nature as a principal residence, in circumstances 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;

c) no CCA is claimed on the property.

The determination of whether there has been a structural change to a taxpayer’s property to make it more suitable for rental or business purposes requires a review of the particular facts in each case. However, where a taxpayer undertakes renovations for the purpose of the conversion of a portion of a taxpayer’s principal residence into a separate, self-contained domestic establishment (housing unit) to be used for earning rental income, the partial change-in-use rules will generally apply (that is, the CRA’s administrative policy described above would not apply).

Thus, in the context of the BC SSIP, it is our view that the creation of a Secondary Suite, either within or detached from a Homeowner’s principal residence, to be used for earning rental income will generally trigger a deemed disposition pertaining to the portion of the Property so converted pursuant to subparagraph 45(1)(c)(ii) of the Act.

4. If a deemed disposition pursuant to subparagraph 45(1)(c)(ii) of the Act occurs, can the taxpayer elect under subsection 45(2) such that a disposition will be deemed not to have occurred?

Where a taxpayer is subject to a deemed disposition from a partial change in use of their property to an income-producing use pursuant to subparagraph 45(1)(c)(ii) of the Act, a taxpayer may make an election pursuant to paragraph 45(2)(b) of the Act, such that the deemed disposition that would otherwise arise for income tax purposes not occur. For tax years covered by a subsection 45(2) election, CCA should not be claimed on the property.

Accordingly, in the situation described (that is, a Homeowner who is subject to a deemed disposition on a partial change in use of their Property), a Homeowner can make this election in order to defer the recognition of any gain to a later taxation year. Taxpayers can refer to paragraph 2.60.1 of the PR Folio for instructions on how to file the election.

5. Can a Homeowner claim the PRE pursuant to paragraph 40(2)(b) of the Act for their entire Property (that is, both the portion they occupy and the Secondary Suite) when they dispose of it, for the years that they used the Secondary Suite for rental use?

The CRA’s general views on claiming the PRE are set out in the PR Folio. Generally, if a property qualifies as a taxpayer’s principal residence, an exemption can be claimed under 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) of the property. The term “principal residence” is defined in section 54 and includes, among other things, a property that is a housing unit or a leasehold interest in a housing unit that the taxpayer owned, whether jointly with another person or otherwise, and that was ordinarily inhabited in the year by the taxpayer, the taxpayer’s spouse or common-law partner, former spouse or common-law partner, or child. In general, a taxpayer can designate only one property as their principal residence for a given tax year. Additionally, no other property can be designated as the principal residence of any member of the taxpayer’s family unit for the year. (footnote 10)

The term housing unit is not defined in the Act; however, the term has been broadly defined in jurisprudence and is discussed in paragraph 2.7 of the PR Folio, which explains that a housing unit can include a house; an apartment or a unit in a duplex, apartment building, or a condominium; a cottage; a mobile home; a trailer; or a houseboat.

In general, if two housing units can be enjoyed and ordinarily inhabited separate from each other without access to the other (that is, if each unit is a self-contained unit with its own entrance, kitchen and bathroom), in our view, they will be considered separate housing units for purposes of the PRE. This may be the case notwithstanding the fact that the housing units are part of a single structure or are not on separate legal lots. That being said, as stated, each housing unit must be ordinarily inhabited by the taxpayer or one of the above-mentioned persons to qualify as the taxpayer’s principal residence for a given year, in addition be being designated as such.

For the years in which a Homeowner participates in the BC SSIP and rents their Secondary Suite to a Qualifying Tenant (that is, a person who is not an immediate family member of the Homeowner), it is expected that the ordinarily inhabited requirement in the principal residence definition will generally not be met for the Secondary Suite. (footnote 11) Nevertheless, the principal residence designation can still be made and the PRE can be claimed with respect to the housing unit that the Homeowner resides in provided all other conditions for the housing unit to be considered a principal residence are otherwise met.

Where a subsection 45(2) election is made by a taxpayer for a property that is the subject of a change in use, the property can qualify as the taxpayer’s principal residence for up to four taxation years during which the election remains in force, even if during those years the housing unit was not ordinarily inhabited by the taxpayer or one of the above-described family members of the taxpayer.

However, in accordance with the manner in which the principal residence requirements otherwise operate, a taxpayer may not designate more than one housing unit as a principal residence for any particular year (or, for any particular year after the 1981 tax year, the taxpayer or any other member of his or her family unit). For example, as explained in paragraph 2.50 of the PR folio, a taxpayer’s designation for the same year of one property by virtue of a subsection 45(2) election being in force, and another property by virtue of the fact that he or she ordinarily inhabited that other property, would not be permitted. Thus, in the situation presented, even if the Homeowner filed a subsection 45(2) election, they would only be able to claim the PRE on one of the housing units as permitted by the Act, not the entire Property.

Accordingly, in a situation where a taxpayer has two separate housing units (which would generally be the case in the BC SSIP situation), they will need to determine whether each meets the applicable principal residence requirements and, in the case that both do, which to designate as their principal residence for each tax year.

We trust our comments will be of assistance.

Yours truly,

Pamela Burnley CPA, CA
Manager
Business and Capital Transactions Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 As stated in question 9 in the Frequently Asked Questions section of the BC Housing Secondary Suite Incentive Program website, the minimum loan under the Program is $10,000, which means that construction costs of $20,000 or more need to be incurred by a Homeowner to participate in the Program.

2 As you indicated, the RALs are the median rent levels for each area and unit size as determined by the Canada Mortgage & Housing Corporation in their annual rental market survey.

3 In a situation where the SSIP Loan is not forgiven within the first 5 years of the Program, BC Housing may, at their sole discretion, extend the mortgage term to a maximum of 10 years from commencement (the opportunity for forgiveness will continue) of the BC SSIP.

4 The Secondary Suite must be newly constructed under municipal building permits received on or after April 1, 2023.

5 Based on question 12 in the Frequently Asked Questions section of the BC Housing Secondary Suite Incentive Program website.

6 See also Line 9946 of the T4036 Rental Income guide for discussion of situations where property is regularly rented below fair market value, under the heading “Renting below fair market value”

7 https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4036/rental-income.html

8 https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/it273r2.html

9 https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-1-individuals/folio-3-family-unit-issues/income-tax-folio-s1-f3-c2-principal-reside...

10 Refer to paragraph 2.13 of the PR Folio for explanation of the phrase family unit.

11 A possible exception to this might be where a Homeowner rents the Secondary Suite to their former spouse or former common-law partner who is both a Qualifying Tenant under the BC SSIP and a family member that can meet the “ordinarily inhabited” requirement for purposes of the principal residence definition in section 54 of the Act.