A change in use occurs when your property is changed from income producing to personal use (for example: moving into a property that you have previously used as a rental property) or when it is changed from personal use to income producing (for example: changing your principal residence to a rental property). In addition, the change in use can be for 100% of the property or just a portion of the property (for example: changing your entire principal residence to a rental property or only a portion, such as the basement).
There are tax consequences related to the change in use of your property.
At the time that the change in use occurs, there is considered to be a deemed disposition. This means that for tax purposes, you are considered to have sold the property at the date of the change in use and reacquired it at its fair market value. This deemed disposition can result in a capital gain. The capital gain is the difference between the original purchase price of the property plus any costs related to capital improvements since the purchase of that property and its fair market value at the date of the change in use.
If you change your home to a rental property, you may be able to shelter the full amount of the capital gain by claiming the principal residence exemption and not pay tax on the deemed disposition at the time of the change is use (for more information on the principal residence exemption, see an article we shared here: What you need to know about claiming the principal residence exemption on the sale of property). If the property does not qualify as your principal residence or if the property is being changed from a rental to personal use, the capital gain resulting from the deemed disposition is taxed on your personal income tax return during the year the change in use occurred. Your individual tax rate is applied to 50% of the capital gain. There is a special election that can be filed under certain conditions to defer the recognition of the capital gain until the property is ultimately sold in the future (i.e. 45(3) election).
For more information on this topic, please contact your McCay Duff advisor.Contact Us