Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: 1. Does the CRA have any administrative views as to how big of a variance in a change must occur before applying the rules of paragraph 45(1)(c) of the ITA?
2. Is there any de minimis threshold where the CRA won't invoke the change in use rules?
Position: 1. No.
2. No.
Reasons: 1. There is scope for variations about what level (percentage) of change in use would be considered as substantial change in use in the context of applying the deemed disposition rules provided under paragraph 45(1)(c).
2. Such determinations are questions of fact which require a review of all relevant facts and circumstances.
XXXXXXXXXX
2010-036044
A. Mahendran
September 16, 2011
Dear XXXXXXXXXX :
Re: Principal Residence - Changes in the Proportion of Use of a Property
We are writing in reply to your correspondence of March 15, 2010, wherein you requested our views on the application of the deemed disposition rules provided under paragraph 45(1)(c) of the Income Tax Act (ITA) where there are annual changes in the pattern of occupancy of a principal residence by a taxpayer.
You described a situation where in year 1, a vacation property is used as a principal residence for half of the year and is rented out to an arm's length person for the other half of the year. In year 2, the vacation property is used again as a principal residence for 60% of the time and is rented out for 40% of the time. In year 3, the proportional use goes back to year 1 level, i.e., a 50/50 ratio.
Your Questions:
Specifically, you have asked us the following questions:
1. Does the Canada Revenue Agency (CRA) have any administrative views as to how big of a variance in a change must occur before applying the rules of paragraph 45(1)(c) of the ITA?
2. Is there any de minimis threshold where the CRA won't invoke the change in use rules?
3. Do the change in use rules apply in year 2 and in year 3?
Our Comments:
Paragraph 45(1)(c) of the ITA applies where, after acquiring a property, a taxpayer makes a change in the relation between the use regularly made by the taxpayer of the property for gaining or producing income and the use regularly made by the taxpayer of the property for other purposes. Therefore, pursuant to paragraph 45(1)(c), if a taxpayer changes the proportion of use of a property between income earning and another purpose, the taxpayer is deemed to have disposed of the property at fair market value and to have immediately reacquired it at that cost. If there are annual changes in the pattern of occupancy of a personal use property by a taxpayer, the taxpayer will technically be faced with the change in use rules each taxation year. In certain circumstances, the CRA administratively allows a property to retain its principal residence status even though the property has more than one use or there has been a change in the proportion of use.
The CRA's administrative position is discussed in detail in paragraphs 30 to 32 of Interpretation Bulletin IT-120R6, Principal Residence. Paragraph 30 of the bulletin states that when a taxpayer has partially converted a principal residence to an income producing use, paragraph 45(1)(c) of the ITA provides for a deemed disposition of the portion of the property so converted for proceeds equal to its proportionate share of the property's fair market value. Furthermore, paragraph 31 of the bulletin indicates that the CRA will apply the above mentioned deemed disposition rule where the partial change in use of the property is substantial and of a more permanent nature.
In context of this administrative policy, the word "substantial" is not defined and accordingly, must be given its usual meaning. There is scope for variations about what level (percentage) of change in use would be considered as substantial change in use in the context of applying the deemed disposition rules provided under paragraph 45(1)(c). Therefore, the determination of whether or not a change in use is substantial is largely a question of fact that can best be resolved by a local tax service office.
Paragraph 32 of the bulletin indicates that it is the CRA's practice not to apply the deemed disposition rules but rather to consider that the entire property retains its nature as a principal residence if certain conditions are met by the property. According to the CRA's administrative position, if the income producing use is ancillary to the main use of the property as a residence, and if there is no structural change to the property and no capital cost allowance is claimed on the property, then any increase or decrease in the proportion of use of the property between income earning and personal uses will not be subject to the application of the deemed disposition rules.
In general, a main use of a property is the dominant use being made out of the property. Although the determination of the dominant use of a property is made in respect of a particular taxation year, it is often necessary to consider patterns over a number of years. For example, if a particular use has been the main use for a number of years and in a particular year, there has been a reduction in the level of the particular use because of economic conditions, this does not necessarily mean that the other use has become the main use in that year.
Our comments to your specific questions are as follows:
1. Does the CRA have any administrative views as to how big of a variance in a change must occur before applying the rules of paragraph 45(1)(c) of the ITA?
No. However, according to its published position in paragraph 31 of IT-120R6, the CRA will not apply the deemed disposition rules of paragraph 45(1)(c) for any increase or decrease in the proportion of use of a property as long as the income producing use is ancillary to the personal use of the property and if there is no structural change to the property and no capital cost allowance is claimed on the property. On the other hand, if the income producing use is not ancillary to the personal use of the property as a residence and if there are annual changes in the pattern of occupancy of a personal use property by a taxpayer, the taxpayer may be subject to the deemed disposition rules of paragraph 45(1)(c) annually.
2. Is there any de minimis threshold where the CRA won't invoke the change in use rules?
No. There is no de minimis threshold which may be used in determining whether there has been any change in use in respect of a particular property. Such determinations are questions of fact, which require a review of all relevant facts and circumstances and are normally the responsibility of the tax services office serving the area in which the taxpayer resides.
3. Do the change in use rules apply in year 2 and in year 3?
It depends on whether the income producing use is ancillary or substantial to the main use of the property as a residence, and whether there are any structural changes to the property and any capital cost allowance is claimed on the property. The determination of whether the income producing use is ancillary or substantial is largely a question of fact and can only be determined by a review of the facts and circumstances.
In cases where both uses are in approximately equivalent proportions, the CRA may use additional factors such as the intention of purchasing the property to determine whether the property was purchased mainly for the purpose of gaining or producing income or for personal use. Such a determination is always a question of fact that can only be resolved by a local tax service office.
We trust that the information provided is helpful.
Yours truly,
Sharmini Ratnasingham
Assistant Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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