Change-in-Use Rules under Section 45 – What Every Property Owner Needs to Know

Here at Lakeshore, it is our duty to inform taxpayers and investors of the muddy waters that is Canadas Income Act.

Do you own a property and are thinking of renting it out? This appears to be a topic that catches too many people off guard .. Introducing Section 45 of the Act!

Here's how it works

When you stop using a property personally and start using it to earn income (or vice versa), the CRA treats it as if you sold the property and immediately repurchased it. That triggers a deemed disposition under subsection 45(1) of the Income Tax Act.

The default rule (no election filed)

Under section 45(1), the change in use is deemed to occur at fair market value (FMV). Consequences:

• If converting from personal-use → income-producing: capital gain (or terminal loss if FMV < adjusted cost base) is triggered immediately. 50% of the gain is taxable.

• If converting from income-producing → personal-use: you can usually claim the principal residence exemption on the accrued gain up to the date of change (if it otherwise qualifies).

  
  

For partial changes, section 45(1)(c) apportions the deemed disposition based on the increase or decrease in non-income use relative to the whole property.

Common change-in-use scenarios include:

• Converting your principal residence into a pure rental property

• Moving out of a rental property and turning it into your personal home

• Starting or stopping a business in part or all of your home (e.g., home office, Airbnb, daycare)

• Converting a portion of a property (e.g., renting out the basement while still living upstairs)

• Modifying the structure of your home

Does this mean that you're completely out of luck? No. Fortunately, the act allows for two big relief provisions.

The two big relief provisions

To defer or avoid the immediate tax hit, you have the option of filing (2) different elections depending on your situation:

1. Subsection 45(2) – Election to defer when changing from personal use to income-producing use (whole or partial, e.g., moving and renting our your former property).

   
   

2. Subsection 45(3) – Election to defer when changing back from income-producing use to personal use as a principal residence (whole or partial, e.g., moving into a former rental suite).

Quick tip: Document the change date thoroughly and get a professional FMV appraisal or comparables. The CRA often scrutinizes these on audit, especially for partial-uses based on square footage or other metrics.

The Subsection 45(2) Election – Defer Tax When Shifting from Personal to Income-Producing Use

Subsection 45(2) provides relief when you change a property (or part of it) from personal use to income-producing use. By filing this election, you can defer the deemed disposition under s. 45(1), avoiding an immediate capital gain on the changed portion.

Effect: You're deemed not to have started (or increased) income-producing use under section 45(1)(a)(i) or 45(1)(c)(ii) and can continue claiming the principal residence exemption (PRE) for up to 4 extra years (under the PRE rules in section 54) if you move out for work, school, etc. No FMV disposition occurs at that time. Instead, the gain is deferred until you actually sell or another triggering event happens.

• This applies to full changes (e.g., entire home to rental) or partial ones (e.g., converting a room to Airbnb).

• It also ties into section 13(7)(b) or 13(7)(d)(i) for depreciable property, deferring adjustments to capital cost allowance (CCA).

You can rescind the election in a later year's return, triggering the deemed change as of the first day of that subsequent year.

Filing deadline

The election is filed with your tax return for the year of the change. Late elections may be accepted with penalties.

The Subsection 45(3) Election – Defer Tax When Shifting from Income-Producing to Personal Use

Subsection 45(3) is the counterpart to 45(2), offering deferral when you change a property (or part of it) from income-producing use to personal use as your principal residence. Again, it prevents an immediate deemed disposition under section 45(1)(a) or 45(1)(c).

Effect: No FMV disposition is deemed at the change time. The gain is deferred, and you can apply the principal residence exemption (PRE) to shelter it later.

Be careful though .. Per section 45(4), this election is invalid if you've claimed CCA (depreciation) on the property after 1984 (depreciation deductions block the deferral).

Who should file 45(3)?

• Rental property owners moving in and converting to personal use (whole or part).

• Those decreasing business use in an income property to make it their principal residence.

• Investors winding down rentals to retire in the property.

Filing deadline

Same as the 45(2) election .. the election is filed with your tax return for the year of the change. Late elections may be accepted with penalties.

Wrap-up

With 45(2) for personal-to-income shifts and 45(3) for income-to-personal (principal residence) shifts—plus the 13(7) formulas for change-in-use on depreciable property —these tools can defer significant taxes on full or partial property use changes.

At Lakeshore, we file both types of elections and do professional appraising in-house. Contact us today to learn more.