For Canadian tax purposes, a property can be categorized in various ways depending on how it’s used. It can serve as a principal residence, be rented out to generate income, operate as a commercial space, or function as a combination of these activities. A property can also be classified as capital property or inventory. A property owner can change the way it’s used, turning a home into a rental unit or shifting a rental property back to personal use, for example.
When a person starts using property that was previously used to earn or produce income (business use) for personal purposes (making it their principal residence), the property is deemed disposed, i.e., it is treated as if it were sold at fair market value and repurchased at that same price. This can be a taxable event, putting the taxpayer in a tax crunch – no property sold or cash received, but taxes are still due.
A Quick Look at Filing s.45(3) Elections
To help taxpayers, when a housing unit that was once used to earn or produce income is then used by the owner as their principal residence, they can file an election under subsection 45(3) of the Income Tax Act with Canada Revenue Agency (CRA). By doing so, the property is deemed not to have been disposed and taxes are not due until the taxpayer actually sells the property. The election takes the form of a letter to the CRA, typically filed with the taxpayer’s tax return for the year in which the property is sold, unless requested earlier by the CRA.
This election cannot be made, however, if Capital Cost Allowance has been deducted for the property.
Completing Tax Forms
When a taxpayer elects under subsection 45(3) of the Income Tax Act to defer the recognition of capital gains resulting from a change in use of property from income-producing to personal use, the written election should clearly identify the property, specify the year of the change in use, and indicate that the election under subsection 45(3) is being made.
Written Election Statement
There is no prescribed form for this election; however, it must include sufficient detail to satisfy the CRA that the conditions of the provision are being met.
Key details to provide in a written election include:
- The address and legal description of the property
- The date of the change in use
- A statement that the taxpayer is electing under subsection 45(3)
- An acknowledgment that the property was previously used to earn income and is now being converted to personal use
It is also important to note that you can’t make this election if capital cost allowance (CCA) has been claimed on the property after 1984.
Keep a copy of the written election for your records. If you file the election late, the CRA may still accept it, provided you have a valid reason and submit a written request for a late-filed election.
Filing a Schedule 3 for Capital Gains (or Losses)
Even when a subsection 45(3) election is made, filing a Schedule 3 may still be required in the year the property is ultimately sold. When the property is disposed of, the taxpayer must report the capital gain in that year, using the original adjusted cost base and proceeds of disposition.
However, in the year of the change in use, a Schedule 3 is typically not used to report a capital gain if the subsection 45(3) election is validly made. The gain is deferred, and no disposition is triggered for tax purposes at that time. Still, some taxpayers choose to file a nil disposition entry on Schedule 3 in that year to document the change in use and reference the election to help maintain consistency and clarity in their tax file.
Protect Yourself from Audits & Reassessments
Contact us immediately if you’re unsure about how to draft the written election or determine your eligibility. These elections can get complicated, especially for properties with multiple owners, inherited properties, and those with mixed uses. An incorrect or incomplete filing can affect your ability to defer capital gains and can lead to reassessments or penalties.
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.
