The article “Can you save tax by moving into your rental property?” was originally published in MoneySense on April 18, 2023. Photo by Ketut Subiyanto from Pexels.
Moving into a co-owned property has capital gains tax implications, but there are other financial impacts to consider as well.
“I have a house I was renting in the past and now want to move into as my primary residence. Is there a length of time that I need to live in it to ensure capital gains will not apply on my death, or will capital gains apply based on the years it was rented?
Also, if I co-own this house with a colleague (not spouse/partner), is it automatically assumed to be “joint tenancy” or is it assumed to be “tenants in common” if it is not specified (i.e. the title just shows the two names)?” – Debra
Capital gains when moving into a co-owned property
When you have a change in use for real estate you own, Debra, you are considered to have sold it and then reacquired it immediately. The transaction is considered to have taken place at the fair market value for the property, so you cannot assume an artificially low value. This generally results in a capital gain if the property has appreciated. If you have claimed depreciation (as capital cost allowance), the previous claims are brought into income in that year (known as recapture of capital cost allowance).
In your case, when changing a rental property to a principal residence, you may be able to elect to defer the capital gain. You cannot elect this if you or your spouse or common-law partner claimed capital cost allowance deductions in the past. Otherwise, you can elect to defer the capital gain until you sell the property.
How to defer capital gains
In order to claim the tax deferral, you need to prepare a letter and attach it to your tax return. The letter does not necessarily need to be submitted in the year that you move into the property. It can be as late as the due date for your tax return in the year you sell the property—or earlier, if Canada Revenue Agency (CRA) asks you to make the election. There is no specific format the letter must follow, but it should identify the property and state that you are electing to have subsection 45(3) of the Income Tax Act apply to it.
You may be eligible to designate the property as your principal residence for up to four years prior to moving into it, assuming you did not claim—or do not intend to claim—another property as your principal residence for those same years. This can reduce some of the capital gains tax that accumulated prior to moving into it.
Making this election, Debra, may allow you to defer the capital gains tax on the property as late as the year of your death, as this is considered to be a deemed sale.
If you have a mortgage used to purchase the rental property, the interest will likely no longer be tax deductible. This is because the debt no longer applies to a rental property being used to generate taxable income. The debt also becomes a personal use debt, like the property.
How joint ownership affects capital gains
The joint ownership angle has a few nuances, Debra. If you are not sure how the joint ownership of the property was done originally, you should talk to a real estate lawyer to confirm it—ideally, the lawyer you used to purchase the property in the first place.
There are two types of joint ownership. Joint tenancy with rights of survivorship is most common. It is generally used by spouses so that if one dies, the property passes directly to the survivor.
Joint ownership as tenants in common is less often used, but it makes sense in a situation where you may not want the ownership to pass to the survivor upon your death. If you bought a property with a friend or non-spouse family member, tenants in common may be most appropriate.
If you want to have more control over your share of the property, during your life or upon your death, you should probably own the home as tenants in common.
That said, moving into the property creates complexity. If you are living in a property that is owned 50% by your colleague, will you be paying them rent equal to 50% of the fair market rent? Who will pay the expenses? What if you want to do renovations? These answers will help you decide if moving into the rental is in your best interest, beyond the tax implications.
Your colleague will continue to accumulate deferred capital gains if they continue to own the property while you live there.
You may both want to consider what happens with the property if either of you becomes incapacitated.
You should consider buying out your colleague so that you own your home entirely, Debra. Although the good news is you can defer your capital gains tax, there are other complexities here beyond just your tax implications.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.
