26 July 2024 External T.I. 2024-1007731E5 - BC Secondary Suite Program - PRE

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. Whether a homeowner would be subject to a deemed disposition upon the creation of a secondary suite under the BC SSIP because of a partial change in use of their property to an income-producing use. 2. Whether a homeowner can claim the principal residence exemption for their entire property (that is, both the primary residence that they occupy and the secondary suite) when they dispose of it for the years that they used the secondary suite for rental use under the program.. 3. What are the income tax consequences to a homeowner, at the end of the program’s five-year term, in the following situations:

(a) a homeowner continues to rent their secondary suite for an additional term of say five or ten years or longer (that is, the secondary suite continues to be used in a rental arrangement).

(b) a homeowner begins to use their secondary suite for personal use such as for a dwelling for a family member). We have assumed that in this situation there would either be no payment of rent or perhaps the payment of rent on a cost recovery basis only. In other words, the secondary suite is being used for personal use and the activity would generally not constitute income from a source for the homeowner.

Position: 1. Question of fact but likely yes. However, a subsection 45(2) election may be made to defer any income tax implications 2. See comments 3. General comments provided.

Reasons: 1. When there has been a change in the relation between the use regularly made of the property as a principal residence and the use regularly made of the property for gaining or producing income, there will be a deemed disposition. 2. A secondary suite that is a self-contained unit will generally be a second and separate housing unit from the housing unit that a homeowner continues to occupy as their primary residence.

XXXXXXXXXX									2024-100773
										Christina Foggia, CPA CA

July 26, 2024

Dear XXXXXXXXXX:

Re: BC Secondary Suite Incentive Program – Principal Residence Exemption and Partial Change In Use

This is in reply to your correspondence of February 14, 2024, wherein you requested our views concerning the potential income tax implications to a homeowner who participates in the BC Secondary Suite Incentive Program (“BC SSIP” or the “Program”), a program administered by the BC Ministry of Housing (“BC Housing”). More specifically, you asked about the partial change in use rules and the principal residence exemption.

Background and Facts:

Briefly, 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)

For the SSIP Loan (plus accrued interest) (footnote 2) 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 3) 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.

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.

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. 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, as long as it is consistent with the Residential Tenancy Act. (footnote 5)

For further program details refer to the BC Housing Secondary Suite Incentive Program website.

Questions

1. Whether a Homeowner would be subject to a deemed disposition upon the creation of a Secondary Suite under the BC SSIP because of a partial change in use of their Property to an income-producing use.

2. Whether a Homeowner can claim the principal residence exemption (“PRE”) for their entire property (that is, both their primary residence that they occupy and the Secondary Suite) when they dispose of it, for the years that they used the Secondary Suite for rental use under the Program.

3. What are the income tax consequences to a Homeowner, at the end of the Program’s five-year term, in the following situations:

(a) a Homeowner continues to rent their Secondary Suite for an additional term of say five or ten years or longer (that is, the Secondary Suite continues to be used in a rental arrangement).

(b) a Homeowner begins to use their Secondary Suite for personal purposes, such as for a dwelling for a family member. We have assumed that in this situation there would either be no payment of rent or perhaps the payment of rent on a cost recovery basis only. In other words, the Secondary Suite is being used for personal use and the activity would generally not constitute income from a source for the Homeowner.

Our Comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (“Act”) and related legislation (where referenced). 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. Whether a Homeowner would be subject to a deemed disposition upon the creation of a Secondary Suite under the BC SSIP because of a partial change in use of their Property 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 fair market value (“FMV”). Any gain otherwise determined on the deemed disposition is usually eliminated or reduced by the PRE. However, paragraph 2.59 of Income Tax Folio S1-F3-C2 Principal Residence (“PR Folio”) (footnote 6) 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).

Accordingly, whether a partial change in use and deemed disposition of a portion of a taxpayer’s property occurs pursuant to the rules in subparagraph 45(1)(c)(ii) of the Act is a question of fact that can only be made on a case-by-case basis. Nonetheless, 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.

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 to an income-producing use), 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.

2. Whether a Homeowner can claim the PRE for their entire property (that is, both their primary residence that they occupy and the Secondary Suite) when they dispose of it, for the years that they used the Secondary Suite for rental use under the Program.

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. 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 7)

As previously noted, the term “principal residence” means, among other things, a property that is a housing unit. 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 8) 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 to deem the property to continue to be used for its original use (that is, as a personal use property), 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. (footnote 9)

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.

3(a). What are the income tax consequences to a Homeowner who, at the end of the Program’s five-year term, continues to rent their Secondary Suite for an additional term of say five or ten years or longer?

Very briefly, a Homeowner who continues to use their Secondary Suite for rental purposes, after the completion of the 5-year Program term, will not be subject to an additional partial change in use and deemed disposition pursuant to paragraph 45(1)(c) of the Act because the use of the Secondary Suite would not have changed from the time of the initial change in use. In other words, the Secondary Suite would continue to be used for income earning purposes.

Concerning the PRE, the Secondary Suite will generally not be considered to be a principal residence of the Homeowner since it is a separate housing unit that will generally not meet the ordinarily inhabited requirement as it continues to be rented. However, as explained previously, the PRE will still be available in respect of the portion of the Property that the Homeowner continues to reside in (that is, their primary residence), provided the relevant conditions in the principal residence definition continue to be met.

3(b). What are the income tax consequences to a Homeowner who, at the end of the Program’s five-year term, begins to use their Secondary Suite for personal purposes, such as for a dwelling for a family member?

If a Secondary Suite that was converted to an income-producing use is later converted back to a non-income producing use (that is, as the Homeowner’s principal residence or for other personal use that does not constitute a rental arrangement), there is a second deemed disposition (and reacquisition) thereof at FMV. This second deemed disposition may result in a capital gain, which will generally not qualify to be reduced or eliminated by the PRE, since the gain is attributable to the period of use of such portion of the Property for income-producing purposes.

However, where a taxpayer is subject to a deemed disposition from a partial change in use of their property to a principal residence pursuant to subparagraph 45(1)(c)(i) of the Act, a taxpayer may make an election pursuant to subsection 45(3), such that the deemed disposition that would otherwise arise for income tax purposes not occur and to defer the resulting gain to a later year. Note that this election may only be made if, among other conditions, the property, or a portion thereof, becomes the principal residence of the taxpayer, and pursuant to subsection 45(4), where no capital cost allowance has been claimed in regard to the property for any tax year ending after 1984 and on or before this second change in use.

In the situation where a subsection 45(2) election was previously filed by a Homeowner upon the initial change in use of the Property to deem the Property to continue to be used for its original use ( that is, for personal use), no subsequent deemed disposition upon a conversion of the Property back to personal use would be considered to occur.

As mentioned, for purposes of the PRE, a Homeowner can only claim one housing unit as their principal residence. Whether a property containing more than one separate self-contained domestic establishment (housing unit) is considered one or two housing units for purposes of the principal residence definition in section 54 of the Act is a question of fact that can only be determined following a review of all of the specific facts and circumstances of a taxpayer’s particular situation. Factors to be considered in the determination of whether a taxpayer has one or two housing units in a given situation, include, but are not limited to, the extent of integration of the two units, whether or not the units have separate legal titles, separate municipal addresses, separate entrance doors, and separate accounts for utilities and other public service providers, as well as the use of the units.

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), it is our view they will generally 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. Accordingly, only one unit will be eligible for designation as the taxpayer’s principal residence for any particular year. An exception to this general view might apply in a situation where it can be demonstrated that the two units are sufficiently integrated (both structurally and usage) and as such, are being used for the exclusive use and enjoyment of the taxpayer and their family (that is, the two units are being used together and are functioning as one single family residence).

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 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%.

3 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.

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 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...

7 Refer to paragraph 2.13 of the PR Folio for explanation of the phrase “family unit.”

8 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.

9 For clarity, while the filing of a subsection 45(2) election will deem the Homeowner’s Property to continue to be used for its original use (that is for personal use), it does not alter the fact that the Secondary Suite and the primary residence are two separate housing units. In other words, it does not impact a property’s characterization as one or two housing units for purposes of the PRE.