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Change in Use of Real Estate
- What Happens if I Move into my Rental Property, or Start Renting out my Home?

Income Tax Act s. 45(1), 45(2), 45(3), 13(7), 248(1)

Topics

How to Determine Fair Market Value (FMV)

GST/HST on Change in Use From Short-Term Rentals to Long-Term Rentals or Personal-Use (Principal Residence or Cottage/2nd Home)

Change in Use From Income-Producing Rental Property to Personal-Use (Principal Residence or Cottage/2nd Home)

- S. 45(3) Election - Defer Capital Gain Until Property Sold

Change in Use From Personal-Use (Principal Residence or Cottage/2nd Home) to Income-Producing Rental Property

- S. 45(2) Election - Defer Capital Gain Until Property Sold

- S. 45(2) Late Election re Change in Use

Can I Retroactively Change My CCA Claims for Prior Years?

Example of Change in Use of Entire Property

Change in Use of Part of a Property

What if I Rent Out Part of My Home or Cottage, or Have a Home Office

What if the Use of My Property Changes Constantly?

TaxTips.ca Resources

Canada Revenue Agency Resources

Deemed Disposition

Although this article discusses only the change in use of real estate properties, the change in use rules apply to other types of property as well - see the definition of Property in our Glossary.

When there is a change in use of real estate, either from income-producing to non-income-producing personal-use (e.g., principal residence or cottage/second home), or from personal-use/non-income-producing to income-producing, there is a deemed disposition. The owner is deemed to have disposed of the property (land and building), and to have immediately reacquired it, with both transactions done at fair market value.

How to Determine Fair Market Value (FMV)

In order to determine the FMV upon a change in use, the taxpayer should get a professional appraisal. If an appraisal isn't done at the time of change in use, a professional appraiser can probably provide an appraisal for the date of the change in use. From looking at Tax Court cases, it's obvious that CRA does FMV appraisals long after the fact. We found no cases where the taxpayer used something other than a professional appraisal, so cannot say if assessment notices or sales of similar properties would be acceptable to CRA. See also the special rules for determining FMV/new capital cost when there is a change in use from personal use to income-producing.

GST/HST on Change in Use From Short-Term Rentals to Long-Term Rentals or Personal-Use (Principal Residence or Cottage/2nd Home)

Besides being a deemed disposal for income tax purposes (see below), there are GST/HST consequences if a short-term rental property, such as an Airbnb property, is sold, converted to a long-term rental, or if it is changed to personal use. GST or HST may be payable on the market value of the property at the time of the conversion. See:

Short Term Rental Restrictions in British Columbia from Achen Henderson CPAs

Tax alert: new rules for short-term rentals in B.C. from MNP

The GST/HST Implications of Conversions Between Personal Residential Use and Short-term Rentals by Peter Mitchell, CPA - on LinkedIn, but not necessary to sign in to view the article

The GST/HST and the Purchase, Use and Sale of Vacation Properties by Individuals from CRA - search for "Change in use".

GST Memorandum 19-2-3 Residential Real Property - Deemed Supplies - Change-in-use from CRA.

If a short-term rental is converted to personal use, it is also a deemed disposition for income tax purposes (see below).

Apparently, in BC there are 11,000 short-term rentals operating illegally - i.e., without a business licence. See Thousands of short-term rentals operating illegally in B.C., data shows, by Amy Judd of Global News. Unless action is taken by these short-term rental operators, they will be denied deduction of any expenses from their rental income for 2024, under changes from the Federal 2024 Budget. See Denial of Expenses for Non-Compliant Short-Term Rentals. The action they take could be very costly in terms of GST payable.

Unfortunately, many government policies are discouraging investors from becoming landlords, and discouraging development of purpose-built rental properties, even though the government has good intentions. For instance, a major property developer in Metro Vancouver has decided they cannot proceed with a 1,200+ purpose-built rental home project. This is because the combination of BC policies and recent legislative changes, CMHC "median rates" and City of Burnaby policies have made such a project not viable economically. See Bosa Properties Says Burnaby Policies Make Purpose-Built Rental Projects "Unbuildable".

Tax Tip: Before changing your Airbnb to a long-term rental or personal-use property, get advice from a tax professional!

Change in Use From Income-Producing Rental Property to Personal-Use (Principal Residence or Cottage/2nd Home)

When the property use changes completely or partially from income-producing to personal use, the deemed disposition can result in a capital gain. This is calculated by deducting the adjusted cost base of the property from the fair market value at the time of change in use. Where only a part of the property has changed use (duplex, fourplex, basement suite, etc.), then there will be a deemed disposition only for that portion of the property.

S. 45(3) Election - Defer Capital Gain Until Property Sold

When there is a capital gain, under certain circumstances the gain can be deferred by making an election under subsection 45(3) of the Income Tax Act. S. 45(4) of the Income Tax Act does not allow the election to be made if capital cost allowance (CCA) has been claimed "in respect of the property" for any taxation year ending after 1984. If any CCA was claimed prior to 1985, this may result in a recapture of that CCA.

This election is only available if the property becomes, or becomes part of, the principal residence of the taxpayer.

To make the election, a letter should be filed with the income tax return for the year in which the property is eventually sold, or within 90 days of a formal demand for the election from CRA.

If a Quebec tax return is also being filed, a copy of the election should be sent to Revenu Quebec.

Further information on this election can be found in CRA Guide T4037 Capital Gains.

Change in Use From Personal-Use (Principal Residence or Cottage/2nd Home) to Income-Producing Rental Property

When the property use changes from personal-use (non-income-producing) to income-producing , the deemed disposition can result in a capital gain. This is calculated by deducting the adjusted cost base of the property from the fair market value at the time of change in use. The fair market value at the time of change in use is the new adjusted cost base of the income-producing property. However, there are special rules to determine deemed capital cost of the depreciable portion of the property, if the fair market value of the depreciable property (building, for example) is greater than its cost to the taxpayer. See CRA's Change in use rules regarding CCA, deemed capital cost, and recapture. See also the Tax Court Case Donaldson v. The Queen, 2016 TCC 5.

Note that if the property is not located in Canada, and the new adjusted cost base is over $100,000 in Canadian dollars, there will be a requirement to complete form T1135 foreign income verification statement each year in the future while the property is owned.

The deemed disposition must be reported on the tax return. Any gain resulting may be eliminated by the principal residence exemption (PRE) if the property has always been the taxpayer's principal residence. If the property has been the principal residence for only a portion of the time it has been owned, then the gain could still be partially eliminated by the principal residence exemption. Starting with the 2016 taxation year, the disposition will have to be reported on the taxpayer's income tax return even if all of the gain is exempt due to the PRE. Check our article on the principal residence exemption re other changes announced in October 2016.

The net rental income must be reported annually on the taxpayer's tax return. See links at bottom to relevant articles as well as CRA information.

S. 45(2) Election - Defer Capital Gain Until Property Sold

When non-income-producing property has been converted to income-producing, the taxpayer may defer recognition of the resulting capital gain (if any) by electing under subsection 45(2) of the Income Tax Act to be deemed not to have made the change in use. This defers the recognition of the capital gain until the property is ultimately sold. The election should be made when the change in use happens. This election can be made for any property, not just the principal residence.

If you make this election, you still have to report the net rental income you earn, and you cannot claim capital cost allowance (CCA) on the property.

To make the election, attach a letter signed by you to your tax return for the year in which the change in use occurs. Describe the property and state that you want subsection 45(2) of the Income Tax Act to apply.

S. 45(2) Election for Principal Residence

Once this election has been made for a residence that was the taxpayer's principal residence, the property can still qualify as the principal residence for up to 4 taxation years, even if the property is not inhabited during those years by the taxpayer. However, the taxpayer must still be a resident or deemed resident of Canada during those years in order to designate the property as the principal residence. This can only be done if no other property is designated as the principal residence for that same period.

If a Quebec tax return is also being filed, a copy of the election should be sent to Revenu Quebec.

Tax Tip: This can be complicated - you may need to consult with a tax professional!

S. 45(2) Late Election re Change in Use

If the s. 45(2) election was not made when the change in use occurred, CRA might accept a late election under certain circumstances, one of which is that no capital cost allowance has been claimed on the property since the change in use occurred and during the period in which the election is to remain in force. For further information on late-filed elections, see the CRA information Late, Amended or Revoked Elections.

Can I Retroactively Change My CCA Claims for Prior Years?

See our information on this in our Capital Cost Allowance article.

Example of Change in Use of Entire Property

For example, assume a taxpayer rented out their principal residence on June 1, 2006, after living in it since 1996, and moved into a friend or relative's home. The taxpayer filed a s. 45(2) election for the 2006 taxation year. The taxpayer sold the former principal residence in 2012. No capital cost allowance was claimed during the years 2006 to 2012 while the home was rented out.

If the election had not been filed:

	There would have been a deemed disposition in 2006 at fair market value (FMV), with any gain sheltered by the principal residence exemption (PRE).
	When the home was subsequently sold in 2012 there would be a capital gain based on the increase in FMV since the deemed disposal.

Because the election was filed:

The change in use was deemed not to occur, so there was no deemed disposal in 2006.

When the home was subsequently sold in 2012 there would be a capital gain based on the increase in FMV (FMV = the proceeds of sale) since the home was purchased in 1996. The number of years sheltered by the PRE would be 11 (1996 to 2006 inclusive) plus 1 (normal rule for PRE) plus 4 (re s. 45(2) election), for a total of 16 years. The home was owned for 17 years (1996 to 2012 inclusive), so the PRE would shelter 16/17ths of the total gain.

The property may qualify as the taxpayer's principal residence for more than 4 taxation years (under certain conditions) if the reason for the change in use is that the place of employment of the taxpayer or the taxpayer's spouse or common-law partner has been relocated. The conditions (as per subsection 54.1 of the Income Tax Act) include:

the employer must not be related to the taxpayer or the taxpayer's spouse or common-law partner;
the property must be at least 40 kilometres farther from the new place of employment than is the subsequent residence; and
either
1. the taxpayer resumes inhabitation of the property during the term of employment with the same employer, or by the end of the taxation year following the year in which the employment terminates; or
2. the taxpayer dies during the term of the employment.

Change in Use of Part of a Property

Under previous rules, a taxpayer could not elect out of the deemed disposition that arose on a change in use in part of a property. The Federal 2019 Budget included a provision to allow an owner of a multi-unit residential property to make use of the s. 45(2) or 45(3) elections. The legislative change for this was included in Bill C-30, Budget Implementation Act, 2021, No. 1, which received Royal Assent June 29, 2021. This revision allows the election for a change in use of part of a property that occurs after March 18, 2019.

To quote from Budget 2019 Tax Measures Supplementary Information: To improve the consistency of the tax treatment of owners of multi-unit residential properties in comparison to owners of single-unit residential properties, Budget 2019 proposes to allow a taxpayer to elect that the deemed disposition that normally arises on a change in use of part of a property not apply.

What if I Rent Out Part of My Home or Cottage/2nd Home, or Have a Home Office?

When you rent out a part of your home or cottage, or convert part of your home to a home office, you are considered to have changed the use of that part of the home from personal-use to rental property. Depending on the circumstances, when you eventually sell your home, or have a deemed disposition because you stop renting part of it, you may have to report a capital gain on the portion of your home that you rented out.

The CRA Rental Income Tax Guide, T4036, and S1-F3-C2: Principal Residence (links at bottom - see partial changes in use) state that if all of the following conditions are met, you will not be considered to have a change in use:

	the part of the home used for rental purposes is small in relation to the size of the whole property,
	you do not make any structural changes to the property to make it more suitable for rental purposes, and
	you do not claim any capital cost allowance on the part you are using for rental purposes.

If all of the above conditions are met, you will not have to report a capital gain when the property is sold or the rental is stopped. Otherwise, you will have to report a capital gain based on the portion of the house that was rented.

If you rent out a part of your home, CRA's position is that you may only write off losses against other income if you have a "reasonable expectation of profit" from the property rental.