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: The taxpayer built a new home and moved into it and decided to rent out the old home. 1) What is the tax implication on the capital gains arising at the time of the old home's eventual sale. 2) How should the taxpayer report the annual rental income on the personal income tax returns.
Position: 1) There is a deemed disposition and a reacquisition immediately thereafter of the old home at FMV at the time of conversion. The taxpayer may defer the gains by electing under subsection 45(2). 2) The rental income can be business income or property income (question of fact based on additional services provided) but generally is reported as property income on T776.
Reasons: Wording of the Income Tax Act
XXXXXXXXXX 2009-034400
March 16, 2010
Dear XXXXXXXXXX :
Re: Principal Residence
We are replying to your correspondence of October 13, 2009, concerning the conversion of a principal residence into a rental property.
You described a situation where a taxpayer recently built a new principal residence and moved into it without disposing of the old principal residence (the "Old Residence") due to poor market conditions. The Old Residence, which has substantially increased in value since it was purchased in the 1970's, has since been rented out.
You would like for us to comment on the income tax treatment of the capital gain arising from the sale of the Old Residence when it is sold. You would also like to have information on the computation of the annual rental income to be reported on the personal income tax returns.
Our Comments
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office (the "TSO"). We are, however, prepared to offer the following general comments, which may be of assistance.
The income tax rules relating to a principal residence, including the conditions to be met for designating a property as a principal residence and the election under subsection 45(2) of the Income Tax Act (the "Act"), are discussed in Interpretation Bulletin, IT-120R6 - Principal Residence.
Generally, if a property qualifies as a taxpayer's principal residence, the taxpayer can use the principal residence exemption 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 of the Act and generally includes a housing unit, together with the land where it is situated (generally not exceeding one-half hectare), that the taxpayer ordinarily inhabits and designates as a principal residence.
As explained in paragraph 25 of IT-120R6, when a taxpayer completely converts his/her principal residence to an income-producing use, there is a deemed disposition of the property at fair market value and reacquisition immediately thereafter at the same amount. Any gain otherwise determined on this deemed disposition may be eliminated or reduced by the principal residence exemption. However, this deemed disposition on a change in use may be deferred by filing an election under subsection 45(2) of the Act.
A property that otherwise meets the definition of a principal residence can qualify as a taxpayer's principal residence for up to four taxation years during which a subsection 45(2) election (the "Election") remains in force, even if the property is not ordinarily inhabited during those years by the taxpayer or a member of the taxpayer's family unit such as the taxpayer's spouse or common-law partner, former spouse or common-law partner or child.
However, it should be noted that generally only one housing unit per family unit can be designated as a principal residence for any particular year, and this also applies to the period of ownership during which the Election is in force. Whether or not it would be beneficial to a taxpayer to file the Election in any particular case is a question of fact and the taxpayer may wish to obtain professional advice.
Further information concerning the tax treatment and reporting requirements of capital gains can be found in the Canada Revenue Agency ("CRA") Guide T4037 - Capital Gains.
Rental income is subject to income taxation and must be reported in the income tax return filed by a taxpayer. The computation and reporting of rental income are discussed in Guide T4036 - Rental Income. This guide also discusses the type of expenses that can generally be deducted in computing rental income.
As stated in chapter 2 of Guide T4036, form T776 - Statement of Real Estate Rentals, will help the taxpayer calculate the rental income and deductible rental expenses for income tax purposes.
As discussed in chapter 3 of the Guide T4036, the tax depreciation, which is called "capital cost allowance", cannot generally be used to create or increase a rental loss. Further, we would mention that if fair market rent is not being charged, such as may be the case where the tenant is a relative, the amount of loss that may used to offset other income will be restricted.
The above publications can be found on the internet on the CRA website at www.cra-arc.gc.ca.
We trust that these comments will be of assistance to you.
Sandy Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch
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