Principal Issues: 1. Whether a change in use occurs when a taxpayer moves from one unit of a duplex to another unit, which he previously rented, and starts to rent the unit he used to inhabit? 2. Whether a change in use occurs as a result of important renovations made to one unit used for personal purposes without any corresponding renovations being made to the other unit? 3. In a situation described in 2) whether certain expenses incurred in respect to the whole duplex should, after the renovation, be allocated on the basis of the relative FMV or relative cost of each unit rather than based on the square meters of each unit?
4. In a situation described in 2), if the taxpayer were to dispose of the duplex, how should the proceeds of disposition be allocated considering the costs incurred for the renovation of one unit and the increase in value attributable to such renovation?
Position: 1. Generally no, if the size of each unit is the same and the proportion of each use (personal and rental) of the duplex remains unchanged.
2. Generally no, unless the renovations are such that the size of the renovated unit is increased.
3. The allocation has to be reasonable considering all the relevant circumstances. 4. None.
Reasons: 1. Wording of paragraphs 45(1)(a) and 45(1)(c), considering that the duplex is one single property. 2. Wording of paragraph 45(1)(c).
3. In accordance with paragraph 18(1)(a), an expense is not deductible except to the extent it was incurred by the taxpayer for the purposes of earning income. The allocation has to be reasonable in the circumstances. 4. The question is based on assumptions which the CRA is unable to verify.
XXXXXXXXXX 2015-058982 Lucie Allaire, LL.B, CPA, CGA, D. Fisc. February 3, 2017
Dear Sir,
Subject: Change-of-use rules
This letter is in response to your letter of May 26, 2015, in which you requested our views on the above subject.
All statutory references are to the provisions of the Income Tax Act (the "Act") unless otherwise noted.
You referred to a situation in which an individual was the sole owner of a duplex consisting of two units of the same size and having the same characteristics that he acquired at a cost of $XXXXXXXXXX (footnote 1). Upon acquisition of the duplex, the individual lived in one of the units and leased out the other.
At a subsequent point, the individual vacated the previously lived-in unit to move into the previously-rented unit. The unit previously inhabited by the individual was rented out. You stated that after the individual moved, half of the duplex's area continued to be used for the purpose of earning income and the other half continued to be used for personal purposes.
After that time, the individual carried out renovation work that related only to the unit in which the individual lived. The cost of the work, which amounted to $XXXXXXXXXX, was a capital expenditure. According to an assessment obtained from an independent appraiser, the renovation work increased the fair market value ("FMV") of the duplex in the amount of $XXXXXXXXXX. You indicated that in the circumstances, it was reasonable to attribute the increase in the entire FMV to the renovation work done on the unit inhabited by the individual.
We understand that the duplex is a capital property (footnote 2) for the individual and that the work did not change the structure of the duplex in that the two dwellings retain the same dimensions.
Your questions
1. Does the individual's move from one unit to the other unit lead to a change in the duplex's use?
2. Does the renovation work result in a partial change of use occurring?
3. To what extent can the individual deduct, in computing his rental income, certain expenses incurred for the entire duplex that are based to some extent on the value of the duplex, such as property taxes? In particular, you asked us whether the allocation should be made, not on the basis of relative area, but rather on the basis of the cost or FMV of each unit.
4. On a disposition of the duplex, how should the proceeds of disposition be allocated between each unit for the purpose of computing the capital gain, in light of the expenditures incurred for the renovation of the unit and the increase in value arising from the work?
Our Comments
This technical interpretation provides general comments on the provisions of the Act and related legislation, where referenced. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
The CRA is of the view that an immovable is normally considered to be a single property for the purposes of section 45(1), unless the property is legally subdivided into two or more separate properties.
Paragraph 45(1)(a) applies only in the case of a complete change of use, that is to say, where a taxpayer has acquired property for some other purpose and at a subsequent time begins to use it for the purpose of earning income, or vice versa. In the situation under consideration, paragraph 45(1)(a) therefore does not apply.
Paragraph 45(1)(c) governs situations where, at any time after a taxpayer has acquired property, there has been a change in the relation between the use regularly made by the taxpayer of the property for gaining or producing income and the use regularly made of the property for other purposes.
In the situation under consideration, although each of the units in the building had undergone a change of use at the time the individual left the unit he then lived in and settled in the unit that had been previously rented, the relation between the use regularly made by the taxpayer of the property for gaining or producing income and the use regularly made of the property for other purposes had not changed at that time. Therefore, there was no change in use of the property for the purposes of paragraph 45(1)(c) at that time by reason of the move of the individual.
Furthermore, we are of the view that renovations done by the individual to only one of the two units in a situation such as that described would not in itself have the effect of changing the relation between the use regularly made by the taxpayer of the property for gaining or producing income and the use regularly made of the property for other purposes. Our comments would, however, be different if the renovation had the effect of changing the relative area of each unit.
Pursuant to paragraph 18(1)(a), an outlay or expense is not deductible in computing the income of a taxpayer from a business or property, except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property. Where an expense is incurred in respect of all of a property of which only a part is used for the purpose of gaining or producing income, the expense will be apportioned between the two parts of the property so that only the part of the expense that can reasonably be considered to have been incurred in order to gain or produce income may be deducted. Where a taxpayer rents out part of the property in which the taxpayer lives then, as set out in Guide T4036, Rental Income, the taxpayer may use the leased area or the number of rooms leased in the building to apportion the taxpayer's expenses, provided the allocation is reasonable. It is for each taxpayer to make such an allocation in a reasonable manner in the light of all the circumstances applicable to the taxpayer’s situation.
Your last question is based on the assumption that the increase in value of the duplex between the time it was acquired and the time of the appraisal subsequent to the renovation is entirely attributable to the renovation . It also assumes that the increase in value resulting from the renovation would always be reflected in the fair market value of the duplex at the time of disposition. Since the CRA is unable to verify these assumptions, we cannot comment on the tax consequences of the situation described.
We hope that these comments will be of assistance.
Louise J. Roy, CPA, CGA
Manager
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 This amount excludes the cost of the land.
2 Under the definition of "capital property" in section 54.