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When you purchase a new home, it’s common for homeowners to convert parts or all areas of their home into an income-producing space. This can range from turning parts of the space into a rental unit, or finally giving that side hustle the proper office it deserves.
Whatever it is, if it’s a move that you profit from — there’s been a change in use on the property that needs to be reported on your taxes. Many homeowners aren’t even aware of this little caveat which is why they may be get caught with an unexpected surprise down the road.
But to help you navigate this, here’s everything you need to know about change in use terms and what you have to do if you convert your personal home into an income generating one.
Decoding Change In Use
As we mentioned earlier, change in use is when you change your property from a primary residence to a rental or business unit or vice versa. In other words, it goes from personal-use to income-producing, and this change is known as a “change in use” on the property. When this happens, the person who owns the property is deemed to sell and then re-purchase the property based on a Fair Market Value. When this is done, homeowners are required to report the resulting capital gain or loss in the year where that change in use occurs.
It’s important to note that if the property was your primary residence prior to you changing its use, you do not have to pay tax on any gain related to the years that you lived there. You only have to report the gains you received during the period that it was income-producing.
Now, why is this all important to know?
Many homeowners aren’t aware of the tax implications associated with this change but definitely need to be mindful of it. Those who fail to claim it are subject to a higher tax bill and may be subject to penalties (and no one wants that!).
To help you navigate these waters a little easier, let’s breakdown the various change in use scenarios and what you need to do:
From Personal-Use To Income-Producing
In this situation, the change in use implies that you’re taking your personal home (principal residence) and transforming it entirely into an income-producing one, either it’s by establishing your own personal business within the space or turning it into a rental property.
When this happens, homeowners can make a special election that allows them to keep their principal residence without marking it as a business property. If your election is approved, you don’t have to report any capital gain when you change it’s use however you will need to report any rental or business income that your earn in your next income statement and you cannot claim Capital Cost Allowance (CCA) on the property.
If you’re interested in claiming this election, you’ll have to attach a signed letter by you that describes the property and that you want to enforce an election under subsection 45(2) of the Income Tax Act. Once that’s done, you submit it along with your income tax and benefit return of the year the change in use occurred. This election can last up to four years, even if you don’t use it as your primary residence. The main caveat being that you can’t assign any other property as your primary residence. After that four year period is up, that election can be extended indefinitely if the homeowner fits certain criteria, which can all be viewed here.
It’s important to note that once these elections are made, there’s no immediate impact on your income tax situation once you’re back home. But if you decide to change the use of the property again without following it up with another election, any gains made from selling the property may be taxed. So always be sure to look into it beforehand and do the necessary paperwork if needed.
From Personal-Use To Partial-Income Producing
If you’re thinking of turning only part of your home into an income producing property, there are things you need to consider for that as well. You are not considered under change in use if you meet the following conditions:
- The business portion of your property is relatively smaller than the rest of your property that you’re using for personal-use
- You do not deduct Capital Cost Allowance (CCA) on the part of your home you’re using to conduct your business
- You did not conduct structural changes to the property to make it more suitable for an income producing property
If the homeowner doesn’t meet these conditions, they’ll have to deem disposition of the portion of the home that had a change in use, then reacquire that portion of property right afterwards. As we mentioned earlier, the disposition (or selling of the property) and reacquisition is determined by the Fair Market Value at the time this is being done.
If you plan on selling the space, there are certain things you need to keep in mind as well. You need to split the selling price between the primary residence and the income-producing space, as well as report any capital gains on the part of the home that you used for business. This part may require additional paperwork on your end as you may want to apply principal designation for the areas of the home where no change in use occurred. This ensures that there’s a principal residence exemption, as you only have to report capital gains on the portion of the home you used for business.
Who You Can Go To For Help
If you’re thinking about changing the use of your home or in the process of doing so, the best place to go for help is your tax accountant who will help you make you file all the appropriate paperwork. If you’re currently on the hunt for a new home, the next best person to consult about change in use is your realtor! Generally when you’re looking for a new home, you have an idea of what you’ll like to do with your future space. Even if you’re thinking about the possibility of converting part of your new home into a rental or income producing unit at some point during your residence there, it’s worth consulting with your realtor who can walk you through some of the steps mentioned above!
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