Principal Issues: Various questions regarding the application of section 45 in a situation where a cottage is inhabited by the owner for six months of the year while it is rented to others for the other six months.
Position: None. General comments on the possible application of paragraphs 45(1)(b) and (c).
Reasons: Whether section 45 applies to a given situation can only be determined after a review of all the relevant facts and circumstances.
FEDERAL TAX ROUNDTABLE, OCTOBER 7, 2022
APFF CONFERENCE 2022
10. Successive changes of use
Subsection 45(2) is a provision that allows an individual to elect to be deemed not to have begun to use a property for the purpose of gaining or producing income, where there has, in fact, been a change in the use of the property, i.e., the property was previously used for personal purposes (other than gaining or producing income) and is now used to gain or produce income.
Where such an election is made, the general rule that there is a deemed disposition at FMV of the property at the time of the change in use does not apply.
Subsection 45(3) provides that an individual who ceases at any time to use a property acquired by the individual for the purpose of gaining or producing income shall not be deemed to have disposed of the property at that time and to have reacquired it immediately thereafter if the property becomes the taxpayer's principal residence and the taxpayer so elects in writing before a certain date.
Income Tax Folio S1-F3-C2 (footnote 1) clearly states in paragraph 2.54 that an election under subsection 45(3) cannot be made in respect of a property for which an election under subsection 45(2) is in force, where the property is no longer used for the purpose of earning income. This is understandable, since once an election under subsection 45(2) is in force, the property subject to such an election is deemed not to be used for the purpose of earning income. It is therefore difficult to justify saying that the individual has ceased to use the property for the purpose of earning income if subsection 45(2) deems it not to be used for the purpose of earning income.
Take the example of an individual owning a chalet which is occupied personally for a period of six months of the year (May to October), whereas the chalet is rented to others during the other six months of the year. As a technical matter, the chalet undergoes a change in use at two points in the year, in May when the individual begins to live in it and in November when the individual begins to rent it out.
Questions to the CRA
(a) Assuming that the individual does not make an election pursuant to subsections 45(2) and 45(3), must the individual report a deemed disposition at FMV each time there is a change in use of the chalet?
(b) If the individual makes a valid election pursuant to subsection 45(2) on the first change in use, will the individual have to report a deemed disposition when the chalet ceases to generate income six months later? If no deemed disposition occurs at that time, must the taxpayer file a new election pursuant to subsection 45(2) I.T.A. when the chalet resumes generating income the following year?
CRA Response to Question 10(a)
The application of the rules in section 45 requires an analysis of all the facts and circumstances of a particular situation. Since the statement in this question describes only a summary example, the CRA cannot make a definitive or final determination as to their potential application to the example submitted. We can, however, make certain assumptions in order to provide general comments regarding the applicable tax treatment that may be useful in these hypothetical situations.
Paragraph 45(1)(a) applies only where there is a complete change of use of a property, i.e., where a taxpayer has acquired a property for another purpose and at a later time begins to use it for the purpose of earning income, or vice versa.
Consequently, paragraph 45(1)(a) does not apply in this example because the chalet is used partly for the purpose of earning income and partly for some other purpose. Paragraphs 45(1)(b) and 45(1)(c) could, however, apply in certain circumstances.
Paragraph 45(1)(b) applies where property has, since it was acquired by a taxpayer, been regularly used in part for the purpose of gaining or producing income and in part for some other purpose. Consequently, paragraph 45(1)(b) could apply in the example submitted where, since the acquisition of the chalet by the taxpayer, the taxpayer lives in it for six months of the year and rents it out to others for the other six months.
In such a situation, paragraph 45(1)(b) deems the taxpayer to have acquired, for a purpose other than the purpose of gaining or producing income, the proportion of the property used for that other purpose at a cost to the taxpayer equal to the same proportion of the cost to the taxpayer of the entire property. If, in this case, the property is disposed of, the proceeds of disposition of the portion of the property deemed to have been acquired for that other purpose are deemed to be equal to the same proportion of the proceeds of disposition of the whole property.
However, where a principal residence is used in part to produce income, it is CRA's practice not to apply the apportionment in paragraph 45(1)(b) so that the entire property retains its character as a principal residence, if all of the conditions described in paragraph 2.59 of Income Tax Folio S1-F3-C2 are met, namely:
- the income-producing use is ancillary to the main use of the property as a residence;
- there is no structural change to the property;
- no capital cost allowance is claimed on the property.
The question of whether all these conditions are met requires an analysis of all the facts and circumstances of a particular situation. Since the statement in this question describes only a summary example, it is not possible for us to give an opinion on the submitted example.
On the other hand, where a property has, since its acquisition by the taxpayer, been regularly used partly for the purpose of earning income and partly for another purpose, there will be no change in the use of the property for the purposes of section 45 by the mere fact that it is rented out from year to year in the same ratio as between the use regularly made of it for the purpose of earning income and the use ordinarily made of it for another purpose.
However, there will generally be a change in use of a property under paragraph 45(1)(c) if there is a change in the relationship between the taxpayer's use regularly made of the property for the purpose of gaining or producing income and the taxpayer's use regularly made of the property for some other purpose at some time after the acquisition of the property by the taxpayer.
Consequently, paragraph 45(1)(c) could apply in this example if at some point after the taxpayer's acquisition of the chalet there is a change in the relationship between the taxpayer's use regularly made of the chalet for the purpose of earning income and its use regularly made for some other purpose.
Paragraph 45(1)(c) governs situations where 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. Under that paragraph, the taxpayer is deemed in such a situation to have disposed of the property at that time for proceeds equal to the proportion of the FMV of the property at that time that the amount of the increase in the use regularly made by the taxpayer of the property for those other purposes is of the whole use regularly made of the property. Paragraph 45(1)(c) also deems the property to have been reacquired immediately thereafter at a cost equal to that same amount.
Consequently, paragraph 45(1)(c) generally applies whenever there is a change in the relationship between a taxpayer's use regularly made of a property for the purpose of earning income and the use regularly made of the property for some other purpose. As indicated in paragraph 2.58 of Income Tax Folio S1-F3-C2, however, paragraph 45(1)(c) applies where the partial change in use of the property is substantial and of a more permanent nature. In addition, as previously stated, it is CRA's practice not to apply the deemed disposition rule if all the conditions described in paragraph 2.59 of Income Tax Folio S1-F3-C2 are met.
Since the application of paragraph 45(1)(c) requires an analysis of all the facts and circumstances relating to a particular situation, and since the statement in this question describes only a summary example, we are unable to pronounce on its application to the example submitted.
CRA Response to Question 10(b)
As stated above, there will be no change in use of a property for the purposes of section 45 solely by leasing a property from year to year in the same ratio as between its use regularly made for the purpose of earning income and its use regularly made for another purpose. Consequently, the taxpayer in this situation will not have to make the election under subsection 45(2) each year solely because of the six-month rental period in each year.
In this example, the election under subsection 45(2) may be made in a situation where, at some time after the taxpayer acquires the chalet, there is an increase in the use of the chalet for the purpose of earning income over the usual total use of the property described in subparagraph 45(1)(c)(ii).
Where a taxpayer has made an election under subsection 45(2), the taxpayer is deemed not to have begun to use the property for the purpose of earning income. In such a case, there is therefore no change in use for the purposes of section 45 where the property or part of the property is converted to personal use.
However, the taxpayer will have to re-elect by virtue of subsection 45(2) if the property or part of the property subsequently undergoes a new change of use described in subparagraph 45(1)(a)(i) or subparagraph 45(1)(c)(ii).
Lyne Gélinas
October 7, 2022
2022-094216
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Income Tax Folio S1-F3-C2, "Principal Residence", 25 July 2019.