We solve serious CRA tax problems

Help from a CPA Tax Consultant – Change in Use of a Property & Subsection 45(2) Elections

Good corporate tax planning

For tax purposes, a property can be classified in several ways. It can serve as a primary residence, a rental property, a commercial property, or various combinations of these uses. A property can also be classified as capital property or inventory. As the owner of a property, you can change how you use it, such as converting a principal residence into a rental property or vice versa.

Change of Use and Deemed Disposition of a Property

Generally speaking, when the use of a property changes, the tax rules deem (treat it as though) the property was sold at fair market value and immediately repurchased at the same price. This triggers a capital gain (or loss) and can put a taxpayer in a cash crunch – the property is not sold, but the resulting capital gain or loss must be reported in the year the change of use took place. You do not have to pay tax on gains related to years the property was your primary residence; however, taxes are payable on gains realized when the property was not your primary residence.

Filing an Election Under Subsection 45(2) of the Income Tax Act

To mitigate this, subsection 45(2) of the Income Tax Act (ITA) allows a taxpayer to file an election that allows you to defer the deemed disposition (and associated capital gains tax) that would otherwise occur when you change the use of your property. It can also help preserve your ability to claim the principal residence exemption for up to four additional years while the property is being rented out, provided you meet certain conditions. 

If a taxpayer fails to file the election, the CRA will, in some circumstances, accept late elections.

Completing Related Tax Forms and Schedules

To make a 45(2) election, it must be clearly documented and properly reported on the applicable tax forms. The following steps and considerations apply when preparing and filing the necessary forms and schedules:

1. Drafting a Written Election Statement

A written statement must accompany the taxpayer’s income tax return for the year in which the change in use occurs. This statement should clearly indicate that the election under subsection 45(2) is being made. It must describe the property in sufficient detail to identify it and specify the date on which the change in use occurred.

2. Reporting on the Income Tax Return

Although no immediate capital gain is triggered by the election, the taxpayer must still report the election appropriately. This involves:

T1 General (Individuals). Attach the written election statement to the paper-filed return or submit it separately if filing electronically. Ensure it is submitted by the due date of the return for the year in which the change in use occurred.

T2 Corporation Income Tax Return (if applicable). A corporation electing under subsection 45(2) must include a similar statement with its return.

3. Completing Schedule 3 (Capital Gains or Losses)

If no election is made, a deemed disposition at fair market value would typically be reported on Schedule 3 of the tax return. However, when an election is validly filed under subsection 45(2), this schedule does not require an entry for the property until a subsequent disposition or change in use that ends the deferral. At that point, the capital gain must be reported, with the adjusted cost base determined as if the election had not been made.

4. Documenting Capital Cost Allowance (CCA) Claims

Once a property is considered to have been converted to income-producing use, CCA may be claimed. However, claiming CCA invalidates the election under subsection 45(2). Taxpayers must ensure that no capital cost allowance (CCA) has been claimed on the property if they intend to rely on the election. This condition should be verified before filing the return.

5. Keeping Adequate Records

Supporting documents such as property purchase agreements, real estate appraisals, and financial records related to rental income or business use should be retained. CRA may request these materials to substantiate the details of the election and the basis for deferral of capital gains.

6. Consideration of Subsequent Events

If a later change in use occurs (e.g., reconversion to personal use or sale of the property), the taxpayer must revisit the tax treatment and may need to file another election under subsection 45(3) or report the resulting capital gain. Schedule 3 and other applicable forms must be completed accordingly in that subsequent year.

Completing the related tax forms and schedules requires careful attention to the election’s eligibility criteria, the reporting processes, and long-term tax consequences. It is highly recommended that you speak to us for professional tax advice if the property has appreciated significantly or involves mixed-use scenarios.

Special Situations and Exceptions

While subsection 45(2) provides a mechanism for taxpayers to defer capital gains when converting a principal residence into an income-producing property, certain special circumstances can influence its application or restrict its availability. These exceptions should be reviewed carefully before relying on the election.

Ceasing to Be a Resident of Canada

If a taxpayer elects under subsection 45(2) and subsequently emigrates from Canada, the deferral of capital gains may be curtailed. When an individual ceases to be a resident, a deemed disposition of property occurs under subsection 128.1(4), potentially overriding the 45(2) election. The departure tax triggered by emigration can accelerate the recognition of accrued gains on the property, even if the property is not sold.

Trust and Corporate Ownership

Subsection 45(2) applies only to individuals who own property directly. Properties held in trust or by a corporation do not qualify for the election. In particular, beneficial ownership by a trust, even where the property is used as a residence by a beneficiary, is insufficient for the purpose of claiming the election or the principal residence exemption. These ownership structures require distinct tax planning and reporting strategies.

Late or Retroactive Elections

The Canada Revenue Agency may accept late-filed subsection 45(2) elections under specific administrative relief provisions. Taxpayers must demonstrate that the conditions for relief under subsection 220(3.2) or Information Circular IC07-1R1 are met, including evidence of reasonable error and prompt corrective action. However, late elections are not guaranteed and should not be relied upon as a substitute for timely compliance.

 

As experienced and licensed CPA tax consultants, we help our clients handle all tax and accounting issues. Give us a call today at 1 844 340 5771 to schedule an assessment.

ACCA-Logo
AICPA-Logo
Chartered professional accountant logo
Chartered Professional Accountant in Canada, U.S. and U.K.

Testimonial

“Need someone who can talk CRA and walk tax law stuff? I did. After an expensive year of trying to resolve a CRA issue on my own – I was very happy to have Sam Faris in the ring with me. I am confident that no lawyer or CA could have prepared a stronger case report to support my appeal. Sam approached my case professionally and skillfully from all angles possible and personally made sure I understood exactly what was going on; every step of the way.”

M Quan
pro-tip

Pro Tip

ACCESSING THE SMALL BUSINESS DEDUCTION IN YOUR BUSINESS

The Small Business Deduction gives businesses a tax deduction on the first $500,000 of income. This saves an eligible corporation around up to $50,000 in income taxes. There are a number of conditions that have to be met to be eligible for this deduction.

This is an announcement from Aaron Baer, legal counsel to Faris CPA.

I have been working with Faris CPA for more than 10 years.

Faris CPA is being attacked by Kenneth John Weakley (Oct 1969).

I am posting this review because Kenneth John Weakley has been deleting his reviews and has been reposting them, so that Faris CPA's responses don't always show up.

Faris CPA's position is as follows:

Faris CPA is a well-regarded firm that is compliant with CPA Ontario obligations and has a good track record.

Under no circumstances will Faris CPA be paying Kenneth John Weakley any amount.

Kenneth John Weakley's claims do not have any merit.
Response from the owner:Thank you Aaron for your help with this matter. Please see below my entire response to Kenneth John Weakley (DOB: October 20, 1969). “Attention all readers: Faris CPA and 3 other reputable lawyers in the GTA are being aggressively attacked with fake Google reviews posted by Kenneth John Weakley (DOB October 20, 1969). Unfortunately, his repeated blackmailing and extortion attempts for the past few months have failed and he is still hoping to be successful by keep posting those false and fake reviews. Please note all personal information mentioned in our response is available online, publicly available and anyone can access it and none of the information was obtained while doing business with Kenneth John Weakley. Feel free to Google his name and see the below link to confirm. As such, there is no breaching confidentiality issue whatsoever. https://find-and-update.company-information.service.gov.uk/officers/EfbNEs5kNSRQeb9uq8kdZL0LGm8/appointments This is a fake review posted by Kenneth John Weakley (DOB: October, 20 1969). Address: 821A Fulham Road, London, U.K. SW6 5HG
Had a very good experience with Sam and his team. They dealt with my CRA audit in the most efficient way possible. I admire their professionalism and expertise in providing answers to the CRA and providing a perfectly reconciled package which was a key to resolve the tax issue. If you look for a tax consultant firm, hire Farid CPA. 10 stars
Response from the owner:Thank you for the five stars and the positive review.
I was referred to Sam Faris by a family member who highly recommended him to deal with my CRA audit matter which has been ongoing for almost 2 years. Considering that this was a sensitive issue, I needed to make sure that Sam would be the right fit to handle my case. I requested an in-person meeting. I met with Sam for more than 2 hours. He went through CRA proposal letter and immediately identified the weaknesses in CRA’s calculations. He immediately advised on the best approach to dispute this proposal and provided a time line when he will submit the counter analysis. I was impressed with his confidence and his expertise and decided to retain his services. He worked on my file around the clock to ensure meeting the deadline. At the end, Sam was able to reduce the tax bill and I was able to pay it with no hesitation. While Sam was working on the file, he was in a full control with the situation by communicating with the auditor on timely and professional manners. I never felt that I was left in the dark as Sam was always providing me with an update. I do recommend to hire Sam for any dispute with the CRA. Thanks
Response from the owner:Thank you for your positive reviews and kind words.
Had a consultation with Sam about a tax situation and very glad I got professional advice on how to proceed.
Response from the owner:Many thanks for taking the time writing this amazing review.