Principal Residence Deduction October 26, 2005 Window On Canadian Tax Commentary Document number: 2005-0125831E5 Income Tax Act: 54(1)(a), 45(1), 40(1) Interpretation Bulletins: IT-120R6, Principal Residence Information Circulars: IC 70-6R5, Advance Income Tax Rulings Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'arc. PRINCIPAL ISSUES: Contract signed to buy a condo unit before construction started, intended as principal residence. Prior to completion, intention changed and taxpayer intends to rent it out. In this situation, is the no-change-in-use election available to the taxpayer under subsection 45(2)? POSITION: No. REASONS: The condo unit would not meet the definition of a "principal residence" under section 54 for the year 2005, and could not be designated as such because it will not have been ordinarily inhabited in the year by the taxpayer, or a family member (i.e., spouse or common-law partner, former spouse or common-law partner or a child of the taxpayer). At the time the property begins to be used as an income producing property, it will not have previously been used as a principal residence by any persons mentioned above. In this situation, subparagraph 45(1)(a)(i) will not be triggered to deem a disposition of the property and the subsection 45(2) no-change-in-use election would be inapplicable. Reverse situation: If at a later time, the taxpayer were to move into the condo unit, changing its use from income producing to his principal residence, then at that later time, an election under 45(3) may be available to the taxpayer, to defer the deemed disposition that would otherwise occur as a result of the change of use to a principal residence by virtue of subparagraph 45(1)(a)(ii), subject to the provisions of subsection 45(4)
2005-012583 Tim Fitzgerald, CGA XXXXXXXXXX (519)973-7999 ext. 6509 October 26, 2005 Dear XXXXXXXXXX: Re: Principal Residence Exemption and the No-Change-In-Use Election under subsection 45(2) of the Income Tax Act This is further to your letter of April 14, 2005 regarding the principal residence exemption. We apologize for the delay in responding to you. We understand the facts in your situation to be as follows: You are a Canadian resident. During the year 2003 you made a 10% down payment on a condo unit, pre-completion. You expect that construction will be completed, the transaction will close and the condo unit will become available, soon. Your initial intention back in 2003 (when you made the down payment) was to take up residence in the condo unit as soon as you acquired it in 2005. Since circumstances have changed, you now anticipate that you will be settled and living in another city within Canada by the time you actually own the condo unit. Due to your change in circumstances, you are now contemplating a change in plans. Rather than moving into the condo unit upon acquisition of the property, you contemplate renting it out to generate rental income. Your Question: You have asked us whether you can use the no-change-in-use election under subsection 45(2) and designate the condo unit as your principal residence even though, having never lived in it, you plan to rent it out as soon as you take possession of it, while you yourself, live in another city within Canada. Information Circular 70-6R5 explains the processes of an advanced income tax ruling and the fees charged for such services should you require binding assurance from the Canada Revenue Agency. While the following comments are not binding on the Agency, we trust they will clarify our views on the subject of the principal residence exemption as they relate to your expressed area of
concern. All references are to the Income Tax Act (ITA) unless otherwise indicated. Our Comments: Generally speaking, if a property qualifies as a taxpayer's principal residence, the taxpayer can use the principal residence exemption to reduce or eliminate any capital gain for income tax purposes, arising on the disposition or deemed disposition of the property. Where there has been a complete change of the use of a property from use as a principal residence to an income producing use, the taxpayer may file an election under subsection 45(2), which deems there to be no change in use, thereby allowing the taxpayer to defer recognition of the gain on the disposition. The protection given by the election will be denied under paragraph 54(d) of the definition "principal residence" in a taxation year where the taxpayer has made such an election for four or more previous taxation years. To prevent the hardship that this 4-year limitation may produce for taxpayers required to live away from their principal residence for long periods of time by virtue of their employment, section 54.1 renders this limiting provision inoperative if the employee taxpayer satisfies certain conditions. Paragraphs 25-27 of information bulletin IT-120R6 Principal Residence should be consulted for a more complete discussion of the workings of subsection 45(2) and section 54.1. The term "principal residence" is defined in section 54 of the Act. The principal residence exemption is claimed under paragraph 40(2)(b) of the Act or under paragraph 40(2)(c) where land used in a farming business carried on by a taxpayer includes their principal residence. Among other things, the definition in Section 54 says that the "principal residence of a taxpayer for a taxation year means a particular property that is a housing unit [...] that is owned, whether jointly with another person or otherwise, in the year by the taxpayer, (a) where the taxpayer is an individual [...] if the housing unit was ordinarily inhabited in the year by the taxpayer or the taxpayer's spouse or common-law partner, former spouse or common-law partner or by a child of the taxpayer" [Emphasis ours]. The question of whether a particular housing unit owned by the taxpayer was "ordinarily inhabited" in the year by such a person must be resolved on the basis of the facts in each particular case. We refer you to paragraph 5 of Information Bulletin IT-120R6. Even if a person inhabits a housing unit only for a short period of time in the year, this may be sufficient for the housing unit to be considered "ordinarily inhabited" in the year by that person. For example if a person disposes of their residence early in the year or acquires it late in the year, the housing unit can still be considered to be ordinarily inhabited in the year by that person by virtue of that person having lived in it in the year before such
sale or after such acquisition, as the case may be. Having previously lived in it before that time, even if a housing unit is not ordinarily inhabited in the year by the taxpayer or any of the above-mentioned persons, it is still possible for the property to be considered a taxpayer's 'principal residence" for the year, by means of an election under subsection 45(2) or (3). However, in our view if such person never inhabited the housing unit during the year, but merely occupied it for a few days before moving on to a new home, it is unlikely the individual would be considered to have established in the year, "ordinary habitation" in the original housing unit. In the situation you describe you contemplate that upon your acquisition of the property, you will use the condo unit to produce rental income rather than take up residence there yourself. Your contemplated change in plans is prompted by your expectation that by the time the purchase transaction is closed and you actually own the property, you will have already settled and be living in another city. If you do not ordinarily inhabit the condo unit in 2005, and upon obtaining ownership of the condo unit, your first use of it is to produce income, than in our view, the property would not qualify as your principal residence. In such circumstances, there having been no previous use as a principal residence prior to its use as an income producing property, there can be no "change in use" that would trigger a deemed disposition under subparagraph 45(1)(a)(i). Therefore, in answer to your question, it follows that the no-change-in-use election under subsection 45(2) would be inapplicable and could not be made in this situation to designate the condo unit as your principal residence as defined under section 54. We now consider the reverse situation. If in the future, after having already used it to produce income, you (or other persons mentioned) subsequently move into the condo unit and designate it as your principal residence, there would be a change in use, and if its value had increased in the meantime, a taxable capital gain. Subsection 45(3) of the Act allows for the deferral of this gain until you actually dispose of the condo. Generally speaking, net income from rental of the property must be reported in each taxation year. If you plan to change the use of the property to your principal residence at some point in the future, we should caution you now that if you claim capital cost allowance during the time over which the condo unit is used as an income producing property, the ability to subsequently make use of an election under 45(3) in the manner described above, may be lost. By virtue of subsection 45(4) of the ITA, an election made under subsection 45(3) shall be deemed not to have been made, if any deduction of capital cost allowance had previously been allowed in any taxation year ending (after 1984 and), on or before the change in use of the property. We refer you to paragraphs 28 and 29 of IT-120R6 for further discussion in this regard. While we regret that the election under subsection 45(2) would not be
available to you in the scenario you describe in your letter of April 14, 2005, we trust our comments are of assistance to you. If you require further assistance, please contact the Client Assistance Division of your local Tax Services Office. Yours truly, Phil Jolie Director Business and Partnerships Division Income Tax Rulings Directorate Policy and Planning Branch