Change in Use of Property
Principal Residence Exemption | Capital Gains on Principal Residence | Change of Use
If you’re a homeowner in British Columbia thinking about converting your principal residence into a rental property or vice versa, it’s important to understand how the Canada Revenue Agency (CRA) treats this change in use of property. According to CRA rules, any such change of use can trigger a deemed disposition, potentially resulting in capital gains tax, even if you haven’t actually sold the property.
In this blog, we’ll break down what happens when there’s a change of use in BC, what it means for your principal residence exemption, and why getting a professional residential appraisal is a smart move to stay compliant and avoid overpaying on taxes.
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What is Change in Use of Property?
A change of use occurs when the intended use of a property changes, either from income-producing to personal-use or from personal-use to income-producing. For tax purposes, the CRA treats this as a deemed disposition, in other words, it is considered that you have sold your property even though you have not actually sold it.
Sample Situations:
- Renting out your principal residence
- Converting your rental property to a principal residence
- Converting your property to a business
- Converting a business to a principal residence
special situations
Changing your principal residence to an income producing property
When a homeowner decides to convert their principal residence into an income producing property, such as renting it out or using it for business purposes, they may be eligible to make a tax election that delays the need to report any capital gain from the change in use. This means the property can still be considered their principal residence for tax purposes, even though it is generating income.
To qualify for this option, the owner cannot claim depreciation on the property. However, they are still required to report any income earned from the property along with applicable expenses. One of the key advantages of making this election is the ability to continue designating the property as their principal residence for up to four years, even while living elsewhere. This is allowed as long as they do not designate another property as their principal residence during that time and continue to be a resident or deemed resident of Canada.
In certain cases, this four year period can be extended without a time limit. This applies when a person relocates temporarily for work and the move meets specific conditions, such as the original home being at a significant distance from the new place of employment. The person must eventually return to the original property while still employed by the same company or within a reasonable time after leaving that job.
Although this tax election offers some flexibility and can help reduce immediate tax consequences, it does not remove the obligation entirely. If the use of the property changes again in the future and the election is not renewed, the owner may be required to report a capital gain when the property is sold.
To qualify for this option, the owner cannot claim depreciation on the property. However, they are still required to report any income earned from the property along with applicable expenses. One of the key advantages of making this election is the ability to continue designating the property as their principal residence for up to four years, even while living elsewhere. This is allowed as long as they do not designate another property as their principal residence during that time and continue to be a resident or deemed resident of Canada.
In certain cases, this four year period can be extended without a time limit. This applies when a person relocates temporarily for work and the move meets specific conditions, such as the original home being at a significant distance from the new place of employment. The person must eventually return to the original property while still employed by the same company or within a reasonable time after leaving that job.
Although this tax election offers some flexibility and can help reduce immediate tax consequences, it does not remove the obligation entirely. If the use of the property changes again in the future and the election is not renewed, the owner may be required to report a capital gain when the property is sold.
Changing your rental or business property to a principal residence
If you decide to convert a rental or business property into your principal residence, there is a tax election available that can allow you to delay reporting any capital gain until you eventually sell the property. This can be a strategic advantage, particularly if the property has appreciated in value. However, this election comes with specific conditions. You cannot use this option if you, your spouse or common law partner, or a trust where either of you is a beneficiary, has claimed depreciation on the property in any tax year after 1984 and before the date you made the change in use.
It is important to note that the election only applies to deferring capital gains tax. If depreciation was claimed before 1985, you may still have to report a recapture of that amount as income in the year the property use was changed.
One of the unique benefits of this election is that it allows you to designate the property as your principal residence for up to four years even before you begin living in it. This feature can be useful if you are preparing to move into the property at a later date but want to preserve its tax advantages in the meantime.
It is important to note that the election only applies to deferring capital gains tax. If depreciation was claimed before 1985, you may still have to report a recapture of that amount as income in the year the property use was changed.
One of the unique benefits of this election is that it allows you to designate the property as your principal residence for up to four years even before you begin living in it. This feature can be useful if you are preparing to move into the property at a later date but want to preserve its tax advantages in the meantime.
Changing part of your principal residence to rental or business or vice versa
When only a portion of your principal residence is converted to business or rental use, the tax implications can be more nuanced. Before March 19, 2019, there was no option to avoid the deemed disposition that typically applies in such situations. However, after that date, it became possible to file an election under specific provisions of the Income Tax Act that allows you to bypass the deemed sale and reacquisition of the portion of your property undergoing a change in use.
If no election is made, the Canada Revenue Agency will usually consider that part of your principal residence to have changed its use if it begins to generate rental or business income. That said, there are exceptions. If your business or rental use of the space is minimal in relation to your overall use of the property as a residence, if no structural changes are made to accommodate commercial use, and if you do not claim depreciation on that portion, the CRA may allow you to treat the home as a single-use property for tax purposes.
In situations where these conditions are not met and no election is filed, a partial deemed disposition occurs. This means you are treated as having sold and immediately repurchased the relevant portion of the property at its fair market value at the time of the change. That portion’s value is based on its proportional share of the overall property. Understanding this process is important because it could result in capital gains that are taxable even if you continue living in the home.
If no election is made, the Canada Revenue Agency will usually consider that part of your principal residence to have changed its use if it begins to generate rental or business income. That said, there are exceptions. If your business or rental use of the space is minimal in relation to your overall use of the property as a residence, if no structural changes are made to accommodate commercial use, and if you do not claim depreciation on that portion, the CRA may allow you to treat the home as a single-use property for tax purposes.
In situations where these conditions are not met and no election is filed, a partial deemed disposition occurs. This means you are treated as having sold and immediately repurchased the relevant portion of the property at its fair market value at the time of the change. That portion’s value is based on its proportional share of the overall property. Understanding this process is important because it could result in capital gains that are taxable even if you continue living in the home.
What is the Principal Residence Exemption?
The principal residence exemption (PRE) is a tax benefit for Canadian homeowners. It’s one of the most important tax breaks offered to Canadians, which can reduce or eliminate any capital gain occurring for income tax purposed on the disposition. The principal residence exemption allows you to exclude the capital gain from the sale of your home from your income. However, it only applies to properties that are used as your principal residence for each year you own them.
How change of use affects the principal residence exemption?
When you convert your home into a rental property, it may no longer qualify as your principal residence. This can affect your ability to claim the Principal Residence Exemption, which helps reduce or eliminate capital gains tax when you sell. The good news is that with proper documentation, you may still be able to preserve the exemption for a certain period.
An appraisal at the time of the change is essential. It provides a clear and accurate record of the property’s market value at that specific point in time. This helps you establish a baseline that can be used later if the property is sold or if you need to report a gain. Having a professional appraisal adds credibility to your records and gives you peace of mind knowing that your property value is well documented.
Why do you need a change of use appraisal?
- CRA-Compliant Valuation: When there's a change in use of property, the CRA will require a Fair Market Value report for the time of the change. A professional appraiser will provide you a FMV that meets CRA standards and requirements.If you fail to report and accurate FMV, it could result in an audit or a reassessment that leads to additional taxes and penalties.
- Support for Principal Residence Exemption: If you’ve converted your property from a rental to your primary residence, you may qualify for the Principal Residence Exemption (PRE), which can significantly reduce or eliminate capital gains tax. To claim this exemption, it’s essential to have precise documentation of the property’s value at the time of the change in use. A professional appraisal can serve as critical evidence, helping you on your claim and protect your eligibility for this valuable tax benefit.
- Capital Gains Planning: Understanding your property's current market value helps you make informed decisions regading capital gains taxes and potential future sales. With the right valuation, you can better understand your tax obligations and plan accordingly.
- Protection During Audits: If your property use changes, you'll want to have a reliable appraisal report to back up your tax fillings in case of a CRA audit. A well-documented appraisal report can protect you from paying additional taxes or fines due to improper reporting.
The Change of Use Appraisal Process
1- Schedule an Appraisal: The process starts by booking your appraisal with a qualified appraiser. Helpful records like renovation details, purchase history, or past appraisal reports can provide valuable context and a more accurate valuation.
2- On-Site Appraisal: An experienced appraiser visits the property to assess its condition, features, layout, and any improvements that could affect its market value. They take detailed notes and photographs and analyze how the property compares to others in the area. This site visit is essential for an objective and supportable valuation.
3- Market Research and Valuation Analysis:The appraisal firm compares the property to similar homes recently sold in the area and analyzes market conditions relevant to the date of the change. This step ensures that the value provided is backed by real data and professional judgment.
4- Receive Your Appraisal Report: You will receive a detailed written report outlining the appraised value, effective date of the valuation, and the supporting data. This document is CRA-compliant and formatted for clarity and professional use.
5- Use the Report for Tax Filling: The appraisal report plays a key role in supporting your tax filing, especially when claiming the Principal Residence Exemption or calculating capital gains. It serves as a credible, third-party valuation that can help you avoid disputes or penalties related to incorrect property value declarations.
Beyond Property Valuation
WesTech’s Key Strengths:
Experienced company established in the local market for over 30 years
Brick and mortar local Vancouver Office where appraisers collaborate
Dedicated client care team offering excellent customer service and professional businesslike interactions whether by phone or email
100% of our appraisers are designated
Boutique firm focussed only in our local market serving Whistler to Chilliwack
Management still actively completing appraisals and are in tune with the market
WesTech Appraisal is your trusted Lower mainland appraiser of choice, offering you the best experience and the highest quality service. Contact us today to find out how we can help you with your appraisal needs.
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