Deciding to move can always be a challenge. What part of town are you in? Are you upgrading? Down sizing? Moving to the country or into a condo right in the middle of downtown?
These are all important questions that everyone who is planning to move thinks about. However, there are other things to consider as well.
What happens if you decide to move but instead of selling your home, you rent it out to tenants? Or you decide now that the kids are all grown up that you want to sell your home in the suburbs and live in your downtown property which you were previously renting out?
What if you’re not going anywhere but you have a great idea for a home business that will require building an addition to your home?
These are only a few examples of situations that occur a lot and will have an impact on your personal tax return either now or in the future. They can give rise to new forms of income and expenses to be reported, plus possible capital gains or recapture.
Generally, when you sell a property that is not your principal residence, it gives rise to a capital gain which will have to be reported on your income tax return. The gain is determined as the difference between the selling price less expenses and the original cost of the property.
Even though in the above cases there was no sale of property, the simple change in use of a property from your home to a rental property or vice versa will trigger a deemed disposition. Basically, Canada Revenue Agency (CRA) will consider it a sale and a reacquisition.
When you have a change in the use of a property, the selling price is considered to be the fair market value (FMV) of the property on the day the use of the property changes. You are then considered to have reacquired the property at that price.
For example, if you purchased your home for $300,000 and the FMV on the day the use of the property changed is $350,000, you are considered to have sold the property and reacquired it at that cost.
Your principal residence is typically your home, but you or your spouse/common-law partner or any of your children must have lived in it at sometime during the year for you to be able to designate the property as your principal residence.
What you report on your income tax return depends on the situation in which you find yourself.
Your principal residence to an income property
Sam and Diane have decided that instead of selling their home, they’re going to keep it and begin renting out to tenants.
What would be the benefit to doing this as opposed to selling the property?
When you sell your principal residence, more often than not there is no capital gain to report as it is eliminated by the principal residence exemption, as long as you have not claimed this exemption on another property for those years.
However, you will still have to come up with a FMV of the home, as this will be the cost you will use to calculate your capital gain or loss when you actually do sell the property in the future.
Sam and Diane are able to file an election with CRA that would designate this property to continue as their principal residence but, if they make this election, they cannot take capital cost allowance (CCA) on the property and no other property can be designated as their principal residence.
This election works best if Sam and Diane are going to be renting or moving into a place with a lower expected appreciation. This election is in effect for four years, but can be extended indefinitely if the following criteria are met:
1. Sam and Diane live away from their principal residence because one or both of them are required to relocate due to employment (you can not be related to your employer);
2. They return to the home in the year after said employment ends; and
3. Their home is at least 40 kilometres farther than their new residence from their new place of employment.
Your rental/business property becomes your principal residence
Let’s use the example of Jim and Pam who, after working for over 30 years in the government, have finally retired and decide they want to sell their downtown home and move into the quiet Kanata neighbourhood where they’ve owned a home they’ve been renting out to tenants. After speaking with their accountant, they decide this is their best option.
How does this work?
If Jim and Pam actually had sold the Kanata property, they may not only have had a capital gain but also recapture if they had taken CCA on that property over the course of time they owned and rented it and the property had appreciated in value.
While a change in use of the property to their principal residence may give rise to the same implications. And once again, the FMV of the property will have to be determined to calculate the capital gain and established the new cost of the property.
They can file an election to postpone the gain to when they actually sell the property on the condition they did not take CCA on the property after 1984. The recapture would still have to be included in their income.
A portion of your principal residence becomes a rental property or used in a business.
It’s important to understand that if you start renting or using a small portion of your home in a business, then a change in use is not considered to have occurred unless you make structural changes to the home for the purposes of renting or operating the business.
So, let’s say young mother Rachel, who has been on maternity leave for the last year, decides instead of going back to work, she and her husband Ross want to build an addition to the side of their house so Rachel can run a full time day care. Once this change in use has occurred, Rachel and Ross would have to report a capital gain on their personal income tax return in the year they actually sell the property, not the year in which the change in use occurred.
They still need to determine the FMV when the change in use happens, in order to have a cost of the income property portion to use in the future. The selling price will then be prorated between the principal residence and the income property. This proration can be based on the number of rooms, square footage, or some other reasonable method. There is no election that can be filed with CRA to designate it as the principal residence.
If you can relate to the situations of Sam and Diane, Jim and Pam, or Ross and Rachel, and have any questions about the tax implications, contact us at 613-728-5831.
