Change in use rules: what happens when a home becomes a rental — or the reverse

Moving out and keeping the old place as a rental feels like a simple decision. For tax purposes it is a sale. The Income Tax Act treats a change between personal and income-producing use as a disposition at fair market value, which can crystallise a gain in a year when no money changed hands. There are elections that defer it, but they have conditions and deadlines, and they are easy to miss.

The general rule

Change the use of a property and you are considered to have disposed of it at fair market value and to have immediately reacquired it at that same value. The reacquisition cost becomes your new adjusted cost base going forward, so the effect is to draw a line under the gain accrued to that date and start a fresh clock.

Where the property was your principal residence for some of the years you owned it before the change, the gain relating to those years is generally sheltered by the principal residence exemption; only the gain for years it was not your principal residence is reportable.

Home becomes a rental: the subsection 45(2) election

If you change your principal residence into a rental or business property, you can elect not to be considered to have started using it as income-producing property. The effect is that no capital gain is reported at the time of the change. The conditions:

• You cannot claim capital cost allowance on the property while the election is in effect.
• The net rental income still has to be reported, every year.
• You can designate the property as your principal residence for up to four years even though you are not living in it — provided you designate no other property as your principal residence for those years and you are resident, or deemed resident, in Canada.

The four-year limit can be extended indefinitely in one specific situation: an employer-required relocation. All of these must hold — you live away because your employer, or your spouse's or common-law partner's employer, wants the relocation; you are not related to that employer; you return to the original home while still with that employer, or before the end of the year following the year that employment ends, or you die during it; and the original home is at least 40 kilometres further from the new workplace, by the shortest public route, than the temporary residence.

To make the election, attach a signed letter to the tax return for the year of the change describing the property and stating that you want subsection 45(2) to apply.

Rental becomes a home: the subsection 45(3) election

Going the other way, you can elect to postpone reporting the disposition until you actually sell the property. Two restrictions matter:

• You cannot make this election if capital cost allowance was deducted on the property by you, your spouse or common-law partner, or a trust under which either is a beneficiary, for any tax year after 1984 and on or before the day the use changed.
• The election applies only to the capital gain. If CCA was claimed before 1985, recapture must still be included in income in the year the use changed.

The election allows you to designate the property as your principal residence for up to four years before you actually occupy it. It must be made by the earlier of 90 days after the CRA asks for it and the filing date for the year in which you actually sell the property.

The CCA restriction is the reason experienced advisers are cautious about claiming capital cost allowance on a rental at all. A modest annual deduction can quietly close off this election years later — one of several reasons the current versus capital expense decision has consequences well beyond the current year.

Partial changes in use

Renting out a basement suite or converting part of a home to business use is a partial change in use, and it has its own treatment. Before 19 March 2019 no election was available to avoid the deemed disposition on a partial change. From that date onward, depending on the circumstances, an election under subsection 45(2) or 45(3) can be made so that the deemed disposition on a partial change in use does not apply.

Even without an election, the CRA generally will not treat a partial change as having occurred if all three of the following hold:

• the rental or business use is relatively small in relation to the use as your principal residence;
• you make no structural changes to the property to make it more suitable for rental or business use; and
• you do not deduct any CCA on the part used for rental or business.

Fail any one of them and there is generally a deemed disposition of that portion, with proceeds and reacquisition cost equal to the proportionate share of fair market value at the time. Those three conditions are the same ones that protect a home office, which is why our guide to the principal residence exemption and business use keeps returning to them.

Fixing the capital cost when the use changes

Where a personal-use property becomes a rental, you have to establish the capital cost for CCA purposes. If the fair market value of the depreciable property at the time of the change is less than its original cost, the capital cost is that fair market value, excluding land. If fair market value is more than the original cost, the capital cost is the original cost plus half of the excess, adjusted for any capital gains deductions claimed. The land is treated as acquired at fair market value. The practical implication is unglamorous but important: get a defensible valuation at the date of the change. You will need it twice.

The bottom line

A change in use is a taxable event even though no cash moves. Decide before the move whether an election is available and whether you want it, get the property valued at the date of the change, and keep CCA in mind because claiming it can foreclose options later. This is an area where the cost of a conversation with a CPA who works with real estate investors is trivial next to the cost of finding out afterwards.

This article is general information for Canadian business owners and is current as of July 2026. It is not tax, legal or accounting advice, and your situation is unique — please speak with a CPA before acting on anything here.

Working through this locally? We advise owners on it as an accountant in Abbotsford.