Turning Your Home Into a Rental: The Section 45(2) Election

You are moving out of your home, maybe for work or family reasons, and you plan to rent it rather than sell. You want to know whether you will lose the principal residence exemption on the years you owned and lived there.

The section 45(2) election exists for this situation. This article explains what it does, the conditions attached, how to make it, and the trade-offs on the rental side. It is general information, and a lawyer or accountant can confirm how it applies to you.

What the election does

Every change in use of a property is treated as a sale at fair market value. Converting your principal residence to a rental therefore triggers a deemed disposition and reacquisition at fair market value unless an election applies.

Subsection 45(2) is that election. If you make it, you are deemed not to have begun using the property to earn income, which avoids the deemed disposition in paragraph 45(1)(c). In plain words, the law lets you carry on as though the home never changed use.

Conditions and time limit

The election applies if all of a principal residence is converted to rental or business use. The property can then be designated as your principal residence for up to four years.

If the home was only partly rented, different rules apply. The CRA usually treats that part as changed in use, with a limited exception where the rental use is relatively small, there are no structural changes and no CCA is claimed.

People often ask whether the four years can be extended. The rules summarized here speak of up to four years. Whether anything longer could apply to your situation depends on the facts, and it is worth confirming with a lawyer or accountant before you plan around it.

How to make the election

The election is made in your return of income. In practice you attach a signed letter to the return. The letter describes the property and states that you want subsection 45(2) of the Income Tax Act to apply.

• Describe the property clearly, including its address.
• State that you want subsection 45(2) to apply.
• Sign the letter and attach it to your income tax return.
• Keep a copy with your records.

If the election or designation is filed late, the penalty is the lesser of $8,000 and $100 for each complete month from the original due date to the date of the request. The Minister may extend the time for an election if you apply within ten calendar years after the end of the relevant tax year. It is far simpler to file on time.

The rental side: income, deductions and CCA

Once you rent the home, the income is reported on Form T776. Net income or loss goes to line 12600 of your T1 return. The owner reports the income, and co-owners report their share in proportion to their ownership.

You can deduct reasonable expenses incurred to earn the rental income, such as interest on money borrowed to buy or improve the property, property taxes for the period it was available for rent, and current-year insurance premiums. Mortgage principal repayments are not deductible. Renting below fair market value is treated as a cost-sharing arrangement, so a rental loss cannot be claimed.

The election has a cost. If you make the subsection 45(2) election, no CCA can be claimed on the property while the election is in effect. Many owners accept this trade-off to protect the exemption, but it is worth comparing both paths with an accountant.

When you sell or move back in

When you eventually sell, the sale must be reported on Schedule 3, and you designate the property by ticking box 1 at line 17900. Form T2091(IND) is included with the return. Reporting is required even if the home was your principal residence for every year owned.

The exemption formula reduces the gain by the proportion of years the property was your principal residence while you were a Canadian resident. The years you cover by the election count toward that proportion, subject to the conditions above.

If you move back in, a separate election under subsection 45(3) may avoid a deemed disposition when income-producing property becomes your principal residence. It must be made in writing to the Minister by the earlier of the 90th day after the Minister demands it and the filing-due date for the year of actual disposition.

What to do next

• Record the date you move out and the date the first tenant moves in.
• Confirm you will not designate another property as a principal residence for the same years.
• Confirm your Canadian residency plans for the election period.
• Decide whether you want to claim CCA, knowing the election stops it.
• Prepare the signed election letter and attach it to your income tax return.
• Keep purchase records, improvement receipts and a market value estimate for the date of the change.

Frequently asked questions