When you have a change in use of a property from being your principal residence to a rental property or vice versa, s45(1) of the Income Tax Act deems that a disposition of the property has occurred. For more information, please see our post regarding the principal residence exemption.
A s45(2) election may be applicable when the change in use is from your principal residence to a rental property. S45(2) postpones the change of use deemed disposition and allows you to maintain the principal residence designation on your home for up to four years after you have stopped living in it. This post will discuss the requirements for the election to be valid and the resulting tax implications.
I will also go over the s45(3) election used when you have a change in use from an income property to your principal residence at the end of this post.
Who can make a s45(2) election?
You must not designate any other property as your principal residence and you must be a resident or deemed to be a resident of Canada. Residency determination of a taxpayer is another big topic for another post. But you do not have to be a permanent resident or citizen of Canada to be resident of Canada. The determination is based on the facts of circumstances of each case.
When to make a s45(2) election?
The s45(2) election should be made during the taxation year in which the change in use occurred. Intuitively, this makes sense, if the s45(2) election was not made you would have to report a disposition of your principal residence on your tax filing for the year.
The CRA allows you to file a late s45(2) election but you may be subject to penalties. Furthermore, you cannot claim Capital Cost Allowance during the period when the property was used for income purposes that you want to claim principal residence exemption on. You should contact us if you plan to make a late election, there could be penalties if the request is seen as retroactive tax planning, there is inadequate documentation, or you are considered negligent in complying with the law.
Tax implications of a s45(2) election
Since you are only allowed to designate one principal residence per family unit, if you decide to make an s45(2) election, you will not be able to designate any other property during that period as your principal residence. Careful consideration should be put into the current and future valuation of the property subject to the election and any other property you own.
Extension of a s45(2) election
The standard s45(2) election allows the principal residence exemption to cover four additional years where you do not live in the property. If the following conditions are met, the four year limit can be extended indefinitely:
- You moved because you or your spouse/common-law partner’s employer wants you to relocate.
- You are your spouse/common-law partner are not related to the employer.
- You return to your original home while you or your spouse/common-law partner are still with the same employer, OR before the end of the year following the year in which this employment ends, OR you die during the term of employment.
- Your original home is at least 40km farther than your temporary residence from you or your spouse/common-law partner’s new place of employment.
You should be retaining and collecting documentation in support of any of the above conditions in case the CRA audits your election. If you are audited for such an election please contact us as these disputes are very fact specific.
Section 45(3) Election
A s45(3) election may be beneficial when the change in use is from an income producing property (rental property) to your principal residence. A successful election will allow you to declare a property your principal residence for up to 4 years before the change in use occurs.
For example, say you have a rental property that has been rented for 5 years that you moved back into as your principal residence for 2 more years before finally selling it. A s45(3) election will allow you to declare the subject property your principal residence for 6 years instead of just 2 years if the election was never made. This could be a huge tax saving.
Furthermore, an s45(3) election eliminates the deemed disposition that would otherwise be required by the CRA in a change in use scenario. You still need to consider the value of the property at the time of the change in use (and expected change in value in the future) to determine whether a s45(3) election is worth it in your scenario. In some scenarios, an s45(3) election might result in a much higher tax burden therefore a careful calculation with an accountant or tax planning lawyer should be conducted.
Similar to the s45(2) election, the s45(3) election is only available if CCA was not claimed on the property. And again, if you have more than one property, you should consider whether the principal residence exemption is more valuable on one property over another.
Unlike the s45(2) election, the s45(3) election is made in the tax year in which the property is actually disposed of, NOT the year in which the change in use occurs.
Conclusion
S45(1) change in use dispositions can seem like a headache but the elections covered above offer some substantial tax savings and tax planning opportunities. This article only covers the main considerations in such an election. To properly consider whether you should make an election we need to calculate the tax savings, consider opportunity costs, tax residency, and a variety of other legal matters. If you are considering such an election or have further questions, please contact us!
Information current as of December 13th 2022.