A change in use occurs if you convert all or part of your principal residence into a property used to earn income, or vice versa. For example, a taxpayer rents out a room in their home for rental income, or a landlord wants to reside in a property that was previously rented out. Regardless of the reason, it’s important to be aware of the tax implications in doing so.
Every time you change the way you use a property, you are considered to have a deemed disposition for Canadian income tax purposes. Barring any elections, you are deemed to have sold and immediately repurchased your property for its fair market value at the time the change in use occurs. If the fair market value on the date of the deemed disposition is greater than its adjusted cost base (ACB) when you last purchased or changed its use, a capital gain will arise.
Full change in use from residential to rental
If your principal residence is converted into a rental property, the capital gain resulting from the change in use can be partly or fully exempt by the principal residence exemption.
Principal residence exemption
- You can only designate one property as a principal residence each year, and it must be a property that you, your spouse, common-law partner, or child(ren) ordinarily inhabited for most of the year
- Individuals cannot designate another property as their principal residence.
- This does not include children who are 18 years old or older, who are married, or who are in a common-law relationship.
Alternatively, you can make an election under subsection 45(2) of the Income Tax Act (ITA) to deem the change in use of your property to not have occurred. This can be useful because the tax implications on a deemed disposition are deferred until the property is sold. The subsection 45(2) election also allows you to designate your rental property as your principal residence for up to four years, even though you or a family member did not ordinarily inhabit the property.
