The article “When your child moves into your rental property: Capital gains and how to claim principal residence exemption” was originally published in MoneySense on July 24, 2023.
When an adult child moves into their parents’ rental property, the family should be clear on a few things, including capital gains, principal residence exemption and more.
Two questions from two separate parents on what they need to do when their child moves into their rental property. Find out how the “change of use,” “principal residence exemption,” and the capital gains on the second property and the home.
What are the tax implications of moving into a rental property?
There can be conflicting info on capital gains tax for moving into a rental property you own. Here’s how to report change in use to the CRA.
” My son, my husband and I own a rental property in equal shares. It was a pre-construction condo. We took possession in mid 2017, and it was registered in 2018. We rented it until 2022. And in January 2022, my son moved into the condo (before that he lived in our house with us). He changed his address on his official documents, but he didn’t officially report it to CRA as his principal residence. Now we are getting mixed advice regarding capital gains tax for this property.
One is that we had to report the change in 2022 (all three of us), and my husband and I should have paid capital gains tax for 2022 as the change was a deemed disposition, whereas my son will not have to do that until the property is sold. This doesn’t make sense as we have not realized any capital gain from this property. We still own it, we are just not renting it anymore.
The second one is that capital gains tax can be deferred with a letter to CRA from the 3 of us making an election to use subsection 45(3) of the Income Tax Act. We never claimed CCA. If this election is the right way to do it, when do we need to file this letter—immediately (i.e., should have done it with income tax for 2022) or when the property is sold? ” Liljana
How to report to the CRA a change in use for a rental property
At MoneySense, we get a lot of questions about real estate and taxes in Canada. This highlights the importance of getting tax advice when you own a second property. There can be income and sales tax implications, and the numbers tend to be big when you are dealing with real estate values.
First off, Liljana, it bears mentioning that when there are multiple owners of real estate, the tax implications can be different from owner to owner. For example, one owner may qualify for first-time home buyer incentives but not another. And the capital gain on a property can be taxable for one owner but sheltered by a principal residence exemption for another.
You mentioned your son changed his address to the condo address but did not report it to the Canada Revenue Agency (CRA). A common misconception is that by changing your address with the CRA, a property becomes your principal residence. I have spoken with people who do this with a rental property, expecting that when they sell it, the sale can then be tax-free.
In your son’s case, Liljana, he does not need to notify the CRA that the property is his principal residence. In fact, a taxpayer does not generally elect to treat a property as their principal residence until they sell it and complete Form T2091IND Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust) as part of their tax filing in the year of the sale.
When a taxpayer moves into a rental property, it is considered to be a “change in use.” A change in use for real estate generally results in a “deemed disposition,” as if you sold the property. The sale price is based on the current fair market value of the property. If the property has appreciated, this would typically lead to a capital gain.
Liljana, the first opinion you were given is correct. But there is more.
Can you avoid capital gains tax by moving into a rental property?
The only way a property owner can avoid declaring a capital gain is based on the second opinion you were given—to file a subsection 45(3) election. This section of the Income Tax Act allows a taxpayer to elect to postpone the capital gain until a property is sold, subject to certain conditions:
- After the change in use, the property qualifies as your principal residence; and
- neither you, your spouse or common-law partner, or a trust under which you or your spouse or common-law partner is a beneficiary has deducted capital cost allowance (CCA) on the property (this is depreciation for tax purposes).
You mentioned you did not claim CCA, and your son has moved into the property. It sounds like he could make a 45(3) election and defer the capital gain until he sells his portion of the property.
How to claim a principal residence exemption
In order for someone to claim a principal residence exemption, a property must be inhabited by the taxpayer or their spouse, common-law partner or child. So, because your son is living in the property, you and your husband could also elect under subsection 45(3) of the Income Tax Act to treat the property as your principal residence and defer the capital gain.
However, there is an additional consideration for you and your husband. A taxpayer can only designate one property as their principal residence for a particular tax year. And only one property per family unit—you and your husband, for example—can be designated as a principal residence. So, if you elect to treat your the condo as your son’s principal residence, it will expose your home to capital gains tax for you and your husband in the future.
I assume your home is worth more than the condo. You only own two-thirds of the condo as well. It is likely that the capital gains tax that will accrue on your home in the future will be more than that of your share of the condo.
Should a child pay rent to parents for a rental property?
One consideration is whether your son will live in the condo rent-free or pay rent to you and your husband equal to two-thirds of the market value rent now that he is essentially tenanting the property. If he pays rent, you could continue to report the property in the same way on your tax returns.
If he does not pay rent, as I gather may be the case, the property was probably deemed to be disposed of by you in 2022. That would trigger a capital gain for you and your husband in 2022.
In your son’s case, he does not need to file a 45(3) election until the earliest of:
- 90 days after the CRA asks him to make the election (which may never happen); or
- the due date for his tax return in the year the property is sold.
The election can be made by attaching a letter to your tax return or sending it to the CRA, identifying the property and stating that you and your husband are claiming it.
Interestingly, if he makes this election in the future, he can elect to treat the condo as his principal residence for up to four years before he moved into it, which may wipe out all but one year of taxation divided by the total years you all own the property.
Does an owner pay capital gains tax for moving into a rental property?
It depends on the steps taken. Liljana, I think your son can make a 45(3) election in the future. Although you and your husband could as well, it may lead to more tax later on your home. You might need to pay some capital gains tax now on the condo’s change in use to personal use. You might also need to pay more tax later on the subsequent appreciation as well from the time your son moved into it to the time you transfer it to him or sell it, or upon the second death of you and your husband. This appreciation will also be taxable, assuming you want to preserve your principal residence exemption for your house.
Should you claim the principal residence exemption on a property you bought your child?
You can claim a property that your child lives in as your principal residence if it is legally or beneficially yours. But this has tax implications for your own home.
” I bought a condo in 2006 in another province for my daughter to live in. It’s registered in my name. I also have a house in another province. I am planning to sell the condo my daughter lives in very soon. Can I claim capital gain exemption in the condo she lived in all these years? ” Bill
Capital gains tax when selling a home your child lives in
Canadian taxpayers may be eligible to claim the principal residence exemption when they sell real estate. Since 2016, real estate transactions have been under more scrutiny with the Canada Revenue Agency (CRA) since taxpayers now need to report all sales on their tax returns, even if the sale is of a tax-free principal residence.
The definition of principal residence for tax purposes
According to the CRA, in order for a property to qualify as a principal residence, it must be:
- A housing unit, which can include a house, a condo, a cottage, a mobile home, a trailer, a houseboat, a leasehold interest in a housing unit, or a share of the capital stock of a co-operative housing corporation;
- Owned by the taxpayer, jointly or otherwise, legally or beneficially;
- Ordinarily inhabited in the year by the taxpayer, their spouse or common-law partner, their former spouse or former common-law partner, or child.
There can be nuances in the principal residence guidelines that may impact your ability to qualify for the exemption. Some examples are if your home was rented out or used for business purposes, if the acreage is significant, or if you owned another property during the same years that you owned the property in question and claimed the principal residence exemption for it.
Legal versus beneficial ownership of a property
An important nuance for you, Bill, is whether your daughter beneficially owned the property. If she did—meaning you were on title, but it was technically hers—she may be able to claim the principal residence exemption herself. This could be the case if she paid all of the ongoing expenses, amongst other criteria. But then the question may be where did the down payment come from, and if the property was in fact beneficially your daughter’s, but legally in your name, why did the two of you not put it in her name in the first place?
The CRA speaks about legal and beneficial ownership in a 2016 interpretation bulletin:
“In common law jurisdictions, two forms of property ownership are recognized – legal and beneficial. Normally ‘legal ownership’ exists when title is transferred to, recorded in, registered in, or otherwise carried in the name of a person. Legal owners are generally entitled to enforce their ownership rights against all other persons. In contrast, the term ‘beneficial ownership’ is used to describe the type of ownership of a person who is entitled to the use and benefit of the property whether or not that person has concurrent legal ownership.”
I am going to go out on a limb here and assume that the property was primarily yours, Bill, even if your daughter chipped in and paid some of the expenses. In this case, you could claim the principal residence exemption on its sale, given it was ordinarily inhabited by your child. But doing so would cause your own home to be taxable someday. This would not be as good of an outcome as having her claim the principal residence exemption herself.
Principal residence exemption guidelines
To keep things simple, say you bought your house and her condo in the same year. You sell her condo after owning it for 10 years and claim the principal residence exemption. And then assume you sell your house after 20 years of ownership. You can only claim one property as your principal residence in a given year, so you would only be able to claim a tax-free capital gain on your house for 10 of the 20 years (half the period). For the other 10 years, the principal residence exemption was used on your daughter’s condo.
If the property was purchased in your daughter’s name originally, she could have claimed the principal residence exemption. You could have loaned her the money for the down payment to protect your interest. But sometimes, banks will make kids sign a letter stating that the parent’s contribution is a gift to protect the bank’s own place as the primary lender on the property. And there may be other reasons you had the property in your name instead of hers.
Should you claim the principal residence exemption on a property your child lives in?
The point is you cannot have your cake and eat it too. You cannot claim a principal residence on a property in which your child lives if it is legally or beneficially yours without compromising your own ability to claim a principal residence exemption on your home for the same years.
The 2016 change to require taxpayers to report all principal residence exemption claims likely indicates that some taxpayers may have been accidentally or intentionally claiming properties that should not have qualified. The introduction of an anti-flipping tax—to fully tax properties sold within a year of purchase starting in 2023—is also likely in response to abusive principal residence exemption claims.
The principal residence exemption can be beneficial for properties that legitimately qualify, but the rules can be complex. Although you might be able to save tax in the short-term on the condo, Bill, just know that you may have a larger tax bill on your house in the future, especially if it is worth more or has appreciated more than your daughter’s condo.
