22 March 2011 Internal T.I. 2011-0396221I7 - 45(2) Election - deemed no change in use

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 late-election under subsection 45(2) can be accepted by the CRA. 2. If late-filed 45(2) election is accepted, what are tax implications regarding the adjusted cost base when the taxpayer subsequently sells the property?

Position: 1. The Minister has the authority to accept a late-filed 45(2) election. 2. General comments.

Reasons: 1. Subsection 220(3.2) of the Act in conjunction with Regulation 600 gives the Minister discretion to accept a late filed election. 2. See comments.

							March 22, 2011

	XXXXXXXXXX  Tax Services Office	HEADQUARTERS
	Audit Division				Tim Fitzgerald, CGA
							(613) 957-8967
	Attention: XXXXXXXXXX 

							2011-039622

The Principal Residence Exemption and the Subsection 45(2) Election

We are responding to your correspondence of February 16, 2011, concerning a situation where a taxpayer would like to make a late-filed election under subsection 45(2) of the Act in respect of a residence that became a rental property in the 2004 taxation year.

We understand the facts to be as follows:

1. At all times, the taxpayer, Ms. A, was a resident of Canada, and a retiree who owned a condo unit in XXXXXXXXXX that she acquired in 2003.
2. During 2003 and 2004, Ms. A ordinarily inhabited the condo unit with her daughter.
3. Ms. A's daughter married in 2004 and moved out of the condo unit. Also in 2004, Ms. A was diagnosed with cancer and in July of that year Ms. A moved out of the condo unit to live with her daughter.
4. In September, 2004, Ms. A fully converted the use of the condo unit to a rental property until she sold the property in May of 2010, realizing a capital gain.
5. Ms. A would like to make a late-filed subsection 45(2) election in respect of the property to deem there to be no change in use of her condo unit to an income earning purpose. The reason given by Ms. A for making the subsection 45(2) election late is that around the time that she filed her 2004 income tax return she had been experiencing a serious illness and, as well, her accountant gave her incorrect income tax advice. Ms. A would like to make the election to enable her to designate the condo unit as her principal residence for years 2005, 2006, 2007 and 2008 even though in those particular years Ms. A did not ordinarily inhabit the condo unit.

You have posed three questions. Firstly, you would like to know whether the CRA can accept the late subsection 45(2) election in Ms. A's circumstances even though Ms. A never returned to live in the condo unit before she sold it in 2010.

Secondly, if the late subsection 45(2) election is accepted by the CRA, you would like to know if there is a deemed disposition and immediate reacquisition of the property at FMV at the end of the first four years during which the election would be in force (i.e., if there is a deemed disposition on December 31, 2008 and deemed reacquisition immediately thereafter on January 1, 2009).

Thirdly, if the late subsection 45(2) election is accepted, you are uncertain as to how Ms. A's adjusted cost base of her condo unit would be affected, if at all, when that election ceases to be in force at the end of the four years (i.e., December 31, 2008).

Our Comments

A change of a property's use from or to an income earning purpose would generally result in a deemed disposition and reacquisition immediately thereafter at fair market value. The change-in-use rules involving a principal residence are discussed in Interpretation Bulletin IT-120R6, Principal Residence, in particular in paragraphs 25 to 29 thereof.

Technical interpretation letter 2008-026574 summarizes in general terms the workings of paragraph 45(1)(a) of the Act and the subsection 45(2) election as follows:

"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). 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 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 answer to your first question, the Minister has discretionary authority to accept a late subsection 45(2) election. Subsection 220(3.2) of the Act in conjunction with section 600 of the Income Tax Regulations grants the Minister discretionary authority to accept a late-filed subsection 45(2) election. In that regard, there is no requirement that the condo unit be re-occupied by Ms. A prior to the sale of the property. However, if CCA is claimed in respect of the property after the change to rental use has occurred and during the period in which the subsection 45(2) election is to remain in force, such late-filed election would not be accepted. More information concerning the conditions for the acceptance of late-filed elections can be found in Part III of the CRA's Information Circular IC 07-1, Taxpayer Relief Provisions.

We would mention that whether or not CCA was claimed in respect of the property and whether or not the conditions in Information Circular IC 07-1 for accepting the late filed election are met in Ms. A's particular situation involve questions of fact to be resolved by taking into account all details and circumstances. In that regard, we feel that your office is in a better position to ascertain the relevant facts and circumstances and advise the taxpayer as to whether your office would be prepared to accept the filing of a late election.

In answer to your second question, if the late-filed subsection 45(2) election is accepted by the CRA, the result would be that paragraph 45(1)(a) of the Act would not apply to deem a disposition and immediate re-acquisition thereafter of the condo unit at FMV by Ms. A in 2004 and at any subsequent time during which the subsection 45(2) election is in force and the condo unit continues to be rented. The subsection 45(2) election would not automatically cease to be in force at the end of four years.

If a late subsection 45(2) election is accepted by the CRA, Ms. A may designate the condo unit as her principal residence for up to four years during which the condo unit was rented. That is, Ms. A could designate the condo unit as her principal residence for the two years 2003 and 2004 during which she ordinarily inhabited the condo unit and for an additional four years during which the condo unit was rented. This would allow Ms. A to compute a higher principal residence exemption under paragraph 40(2)(b) of the Act which she could claim against the capital gain realized on the sale of the condo unit in 2010. It is to be noted that Ms. A can designate only one property as a principal residence for any year.

We would also note that the four-year limitation for taxation years covered by a subsection 45(2) election does not apply if, as discussed in paragraph 27 of IT-120R6, the conditions in section 54.1 are satisfied.

In answer to your third question, if the late subsection 45(2) election is accepted in respect of the condo unit, that election does not automatically cease to be in force at the end of four years on December 31, 2008. As a result of the subsection 45(2) election, Ms. A is deemed not to have begun to use the condo unit for the purpose of earning income in 2004 and therefore, the adjusted cost base is not affected by the filing of the election. For purposes of the capital gains provision in subdivision c of Division B of Part I of the Act, a non-depreciable property's adjusted cost base, as defined in section 54, generally means the property's cost as adjusted in accordance with section 53 of the Act. Assuming there are no adjustments, the cost of the condo unit in 2003 would also be the adjusted cost base for the purpose of computing the capital gain on the property's sale in 2010, if a late-filed subsection 45(2) election is accepted by the CRA.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust our comments are of assistance.

Yours truly,

Sandy Parnanzone
Manager,
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch