Principal Issues: Whether a cottage that is to be used for personal use was purchased with the intention of gaining or producing income or for personal use.
Position: Question of fact.
Reasons: The fact that there was four years of rental income prior to the personal use would be an indication that is was purchased for the purpose of gaining or producing income.
2006-020868 XXXXXXXXXX Charles Rafuse (613) 957-8967 December 18, 2006
Dear XXXXXXXXXX:
Re: Subsection 45(1)
This is in reply to facsimile of September 28, 2006 and our telephone conversation (Rafuse/XXXXXXXXXX ), concerning the application of Subsection 45(1) of the Income Tax Act (the "Act").
You described a situation where two couples purchased a cottage in 2001. The cottage was rented from 2001 to 2005 when the tenant moved out and the cottage began being used by the two couples for their own personal use. You have indicated that when the cottage was purchased the intention was to use it for personal use. However, since the property was being rented at that time and the seller requested that the couples continue to rent the property to the tenant for another four years, the property continued to be rented for the four years.
You understand that a change from personal to income use of a capital property would generally result in a deemed disposition under subsection 45(1) of the Act, which may give rise to a capital gain. Your question is whether the deemed disposition provided under this subsection would arise in the situation you described in view of the fact that the purpose of purchasing the cottage was for personal use, even thought it was rented out for four years.
Our Comments
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to offer the following general comments.
Generally, where a taxpayer has acquired capital property for the purpose of gaining or producing income and has commenced at a later time to use it for some other purpose, as provided in subparagraph 45(1)(a)(ii) of the Act, the taxpayer is deemed, pursuant to subparagraph 45(1)(a)(iii) of the Act, to have disposed of the property at that later time for proceeds equal to its fair market value and, pursuant to subparagraph 45(1)(a)(iv) of the Act, to have immediately thereafter reacquired it at a cost equal to that fair market value. We would mention that whether the two couples purchased that cottage for the purpose of gaining or producing income or for personal use is a question of fact that can be resolved only by an audit. However, the fact that there was four years of rental income would be, prima facie, an indication that is was purchased for the purpose of gaining or producing income.
The deemed disposition under subsection 45(1) of the Act will not apply where an election is made under subsection 45(3) of the Act. The election can only be made where a property that was acquired by a taxpayer for the purpose of gaining or producing income ceases to be used for that purpose and becomes the principal residence of the taxpayer. Principal residence is defined in section 54 of the Act to mean, inter alia,
...a particular property that is a housing unit...that is owned, whether jointly with another person or otherwise, in the year by the taxpayer, if
(a) where the taxpayer is an individual other than a personal trust, the housing unit was ordinarily inhabited in the year by the taxpayer, by the taxpayer's spouse or common-law partner or former spouse or common-law partner or by a child of the taxpayer...
It is a question of fact whether or not a particular property is a principal residence of a taxpayer. For more information, please refer to our Interpretation Bulletin IT-120R6, "Principal Residence". Please see paragraph 4 for the ownership requirement, paragraph 5 for the "ordinarily inhabited" rule and paragraph 28 for an explanation of the subsection 45(3) election.
We trust this information is helpful.
Yours truly,
S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch