Change of Use: Tax Implications of Renting Out the Basement

Key Takeaways

The deemed disposition rule also does apply to partial change of principal residence such as renting out the basement, except the rule considers that you sold and bought back the property at the same price therefore there are no capital gains.

You must not claim capital cost allowance on the rental property that is also your principal residence.

The amount of income generated from the property should be secondary to the main use of the property as your principal residence.

You must refrain from making “material” or significant structural changes to your property.

Many Canadians do not know or fully understand the tax implications of renting out a portion of their house such as a room or the entire basement. In Canada, before March 19, 2019, a partial change in use of a property triggered a deemed disposition. A deemed disposition occurs when you’re considered to have sold a property at fair market value even if you haven’t physically sold it. However, since then, you can elect to avoid this deemed disposition under certain conditions.

In the case of properties which have principal residence designation and have partially converted a portion of the house such as a room or a basement to an income producing dwelling, the application of the deemed disposition rule is slightly different. In this case, the rule considers that the owner(s) sold and bought back the property at the same price due to the principal exemption rule therefore eliminating any capital gains. The deemed disposition exemption for principal residence properties requires that all of the following conditions are met:

Ancillary Income-Producing Use :The income-generating activity is secondary to the main use of the property as your home. For example, renting out a room or using a home office for a small business.

No Structural Change :There have been no major structural changes to the property. The property must remain largely the same physically. For instance, no part of the house has been converted into a separate rental unit or business space.

No CCA Claimed :You have not claimed Capital Cost Allowance (CCA) on the property.

Capital Cost Allowance (CCA) is a tax deduction that allows you to recover the cost of depreciable property based on the class of assets over time. When you own a rental property, you can claim CCA on certain assets, such as buildings, furniture, and equipment used for rental purposes. However, there are important considerations when it comes to claiming CCA for a rental property that is also your principal residence. In the case of principal residences which have claimed CCA, if and when the property is sold, the sale will trigger a CCA recapture where the recaptured amount is added to taxable income during tax filing.

The deemed disposition rule kicks back in when the change in use of part of your property is substantial and permanent. This usually means there has been significant structural change. Examples of some of these properties are:

House to Store: Converting the front half of your house into a store.

House to Rental Units: Changing part of your house into a self-contained rental unit (like a duplex or triplex).

House to Business Premises: Making alterations to your house to create separate business spaces.

As long as the income-producing use is minor, there are no structural changes, and you don't claim CCA, the CRA considers your entire property as your principal residence, avoiding the deemed disposition rule. This simplifies tax reporting and helps maintain the principal residence exemption.

For further information please contact Taxtron Support at 416-491-0333 or visit www.taxtron.ca