Renting Out Your Former Home in Quebec: Change in Use and the 45(2) Election

You are moving, and instead of selling the house or condo you lived in, you decide to rent it out. As far as you are concerned, nothing was sold. As far as the tax rules are concerned, something happened. Our article on reporting and designating your principal residence when you sell covers what happens on the day the property is sold. This one covers an earlier moment: the day your home becomes a rental, and the election that neutralizes that change.

Renting out your home is a change in use for tax purposes

The federal Income Tax Act looks at how a property is used. A home lived in by its owner and a home rented to a tenant are not treated the same way. Moving from one to the other is a change in use.

It happens more often than people think: a job in another city, a couple moving into one partner's place, a growing family buying something bigger without wanting to sell right away. In each case the former home becomes a rental, and the tax question arises the moment the first tenant moves in, not when the property is sold, which may be years later.

At the moment of that change, the law deems you to have disposed of the property at its fair market value and then reacquired it at the same amount. No deed is signed and no money changes hands, but for tax purposes it is as if you sold the property to yourself at that day's market price.

That deemed disposition can have tax consequences in the year of the change. Avoiding it is exactly what the election under subsection 45(2) is for.

What the subsection 45(2) election does

The election under subsection 45(2) lets you be deemed not to have changed the use of the property. While the election is in effect, the law treats the home as if it were still used the way it was before: the deemed disposition at fair market value does not happen.

In practice, the election has two effects:

• it defers the deemed disposition that would otherwise have happened the day the rental began;
• it makes it possible, when you sell, to designate the property as your principal residence for up to four years during which you did not live in it.

The second effect is not automatic. It opens a possibility that is exercised later, through a separate step.

The trade-off: no capital cost allowance

The election has a price. While it is in effect, no capital cost allowance (CCA) should be claimed on the property. CCA is the deduction that normally lets a landlord write off the cost of the building against rental income. By making the 45(2) election, you give up that deduction for as long as the election holds.

The election does not make the rental invisible to the tax authorities either. The rental income remains taxable and is reported every year, along with the related expenses. The election deals with the change in use, not with the rent.

So the choice is between two benefits that do not stack: keeping the option of a longer principal residence designation when you sell, or claiming CCA every year. Which one matters more depends on your situation, and it is a calculation to run with an accountant.

That calculation depends on things like how long you plan to rent, whether you intend to sell or move back, and how you expect the property's value to change. Ideally it happens before the rental starts, because the election is tied to the year of the change in use: once that year has passed, your options are no longer the same.

The election is not the principal residence designation

This is the most common mix-up, and it is an expensive one. The subsection 45(2) election and the principal residence designation are two separate steps, taken at two different times:

• the 45(2) election is made in the year of the change in use, when the rental starts;
• the designation is made in the year of the sale, when the property is actually sold.

The election designates nothing: it only allows the designation, when the time comes, to cover up to four rental years. Making the election without designating the property on sale does not deliver the intended benefit; designating the property on sale without having made the election at the right time limits what you can designate. The designation itself, and how it is reported, is covered in our principal residence sale article linked above.

How and when to make the election, federally and in Quebec

Federally, the election is made with a signed letter attached to your income tax return for the year of the change in use. That is the year that counts: the change in use is dated from when the rental begins.

Quebec provides a corresponding election under its own legislation. Quebec taxpayers file two returns, and the federal step does not automatically carry over to Revenu Québec: check the form and timing of the Quebec election with Revenu Québec directly.

What this article does not cover: going the other way

The reverse situation, when a rental property becomes your principal residence, falls under a different rule, subsection 45(3). It is not the subject here, and the two situations are not handled the same way.

To check your own situation, two sources carry authority. The Canada Revenue Agency (CRA), in particular Income Tax Folio S1-F3-C2, Principal Residence, and Revenu Québec for the provincial side. An accountant or tax specialist can then apply those rules to your numbers.

This article does not constitute tax advice.