Query Letters for Discontinued Rentals
A number of clients have received query letters from the CRA when they have stopped reporting rental income without showing a corresponding disposition of the property for capital gains purposes. The assumption is that if they are no longer renting a property, they must either have sold it or converted it to personal-use (which will result in a deemed disposition at FMV). However, this may not always be the case. For example:
■ In the case of a client who is renting out part of his principal residence, a deemed disposition will only occur if the change in use is substantial. The CRA will not apply the deemed disposition rule if:
— The income-producing use is ancillary to the main use of the property as a residence;
— There is no structural change to the property; and
— No CCA is claimed on the property.
So a client who has been renting out a basement, but decides he would rather use it as a recreation area after the tenant moves out, is not required to report a deemed disposition. In our response to the CRA’s query letter, we should cite paragraph 2.59 of Income Tax Folio S1-F3-C2 Principal Residence.
■ In situations where an entire property is converted from a rental to a principal residence, the client can elect under subsection 45(3) to defer the deemed disposition until the year in which the property is actually disposed of. This election does not have to be submitted until the year in which the property is disposed of or an earlier year if a formal demand for the election is issued by the CRA. So again a deemed disposition will not be reported in the year the conversion took place. For clients in this situation, we would cite paragraph 2.54 of Income Tax Folio S1-F3-C2 Principal Residence.
It should be emphasized that the rules for elections under 45(3) are different from the rules for elections under 45(2) (where a property that was previously used for personal use is converted into an income producing property). Elections under 45(2) must be filed in the year the conversion takes place.
In cases where a property is owned jointly, it should be stressed that the percentage used to report the clients’ respective share of the capital gain must be the same as was used to report the rental income.
For more information contact Raj Katlaria, CPA at 778-926-9226 or email at firstname.lastname@example.org, or visit us at our Surrey, BC office for a personal consultation.
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