# Real Estate Capital Gain and PRE When Converting to Income Property



## beaconhill (Oct 28, 2014)

I am having trouble understanding the PRE exemption in my situation. 

We built a home and moved in in 2004 and moved out in 2005. (No, we have no history of building, moving in, flipping for a profit, and trying to continuously claim a PRE. We had planned to stay in our home longer, but circumstances dictated we move out and convert it to a rental.) 

I assume it is not an issue claiming a PRE for 2004 and 2005, and I believe you automatically get an extra year. I'm going to file an election to claim the PRE for an additional 4 years - unfortunately this will be filed late because I was unaware of the need to file it, and apparently so was my ex-tax preparer. 

Regardless of whether the additional 4 years are granted, I'd like to know how the PRE works. Is it like in one of the 2 examples below? If so, which one?

Example A
Acquire home for $100,000 in 2005.
PRE for 5 years.
Deemed disposition in 2010 at FMV determined to be $300,000.
Sell home in 2015 for $400,000.
Owe capital gain taxes on $100,000 ($400,000 - $300,000 = $100,000)

Or

Example B
Acquire home for $100,000 in 2005.
PRE for 5 years.
Sell home in 2015 for $400,000.
Owe capital gain taxes on $150,000 (50% of the total $300,000 capital gain because PRE for 50% of the total years owned)

This makes a significant difference for me as the market rose significantly at the beginning of ownership, and has tapered off dramatically. So if Example A applies, I can apply the PRE at the beginning during the time of the most significant property appreciation. 

Thank you for any input.


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## nobleea (Oct 11, 2013)

It's example A.

But I'm not sure where you get the 'you automatically get an extra year'. Doesn't really matter about the years, it's the FMV at the time it was converted to a rental. If someone started renting it in 2005, that's when a FMV assessment (by an appraiser) was necessary and any gains from there on are capital gains.
If you don't have a proper assessment available from 2005, they may consider it all capital gains.


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## beaconhill (Oct 28, 2014)

nobleea said:


> It's example A.
> 
> But I'm not sure where you get the 'you automatically get an extra year'. Doesn't really matter about the years, it's the FMV at the time it was converted to a rental. If someone started renting it in 2005, that's when a FMV assessment (by an appraiser) was necessary and any gains from there on are capital gains.
> If you don't have a proper assessment available from 2005, they may consider it all capital gains.


Thank you.

My understanding is that CRA calculates the PRE by taking the number of years your property was considered your principal residence and then adding 1 year. So if you move out and convert your property to an income property in 2005, you can also claim the PRE in 2006. Under certain circumstances, you can also make an election to continue considering your property as your PR for an extra 4 years after you move out. In that case you would get the 4 years, plus the 1 automatic year, for a total of 5 years. 

I am pleased you believe Example A applies, as that is beneficial for me. Now I have to see if the CRA will grant my late filing of the election to extend the PR an extra 4 years.


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## nobleea (Oct 11, 2013)

beaconhill said:


> Thank you.
> 
> My understanding is that CRA calculates the PRE by taking the number of years your property was considered your principal residence and then adding 1 year. So if you move out and convert your property to an income property in 2005, you can also claim the PRE in 2006. Under certain circumstances, you can also make an election to continue considering your property as your PR for an extra 4 years after you move out. In that case you would get the 4 years, plus the 1 automatic year, for a total of 5 years.
> 
> I am pleased you believe Example A applies, as that is beneficial for me. Now I have to see if the CRA will grant my late filing of the election to extend the PR an extra 4 years.


I don't think it matters how many years. It's the FMV when you start getting rental income from it. That would be the value in 2005.


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## beaconhill (Oct 28, 2014)

nobleea said:


> I don't think it matters how many years. It's the FMV when you start getting rental income from it. That would be the value in 2005.


Why wouldn't it be the FMV once the property stops being considered your PR? Otherwise, what is the advantage of filing an election to have the property continue to be considered your PR for up to an additional 4 years?


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## amack081 (Jun 23, 2015)

beaconhill said:


> Why wouldn't it be the FMV once the property stops being considered your PR? Otherwise, what is the advantage of filing an election to have the property continue to be considered your PR for up to an additional 4 years?


Anytime you change the use of the property you are considered to have sold the property at its FMV.

As stated, you could be eligible to designate the rental property up to 4 years as a principal residence while the property is rented out, however you cannot claim CCA during this period (rule of thumb- never claim CCA on housing property). If you moved for a job purposes, than there is no 4 year limit.

The advantage of filing an election to have the property continue to be considered your PR would be to effectively eliminate capital gains if the value of the house increases significantly.


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## nobleea (Oct 11, 2013)

Keeping in mind that one can only have one primary residence at any one time.


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## beaconhill (Oct 28, 2014)

I am clearly missing something. 

If there is a deemed disposition for FMV at time of change of use, and not four years afterwards (if election is filed), what good do the four extra years do for you? I only see the advantage of the four extra years if deemed disposition for FMV happens after the four years when the property has appreciated further.


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## VideoTaxJoe (Jun 24, 2015)

beaconhill said:


> I am clearly missing something.
> 
> If there is a deemed disposition for FMV at time of change of use, and not four years afterwards (if election is filed), what good do the four extra years do for you? I only see the advantage of the four extra years if deemed disposition for FMV happens after the four years when the property has appreciated further.


Beaconhill - your intuition is correct. What the election does is to effectively change the date when the "change in use" to a rental property occurs for tax purposes (moving it up to 4 years later). This change date is the important part as it is the point when you would have a disposition. This means that the new cost base for the property is the value at the new "change in use" date. Your taxes owing would look like this:

a) 2005-2014 increase in value completely eliminated if you designate it for the PRE and the 4 years election is granted (Income Tax Act Subsection 45(2))
b) 2015 increase in value taxable as a capital gain (i.e. taxable at half your normal income tax rate)

For further reading, check out CRA's Folio on it: http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s1/f3/s1-f3-c2-eng.html#N1099F
(this will link you directly to the portin of the document dealing with changes in use)

It is probably a good idea to get a designated accountant to do your returns for this year as there are a bunch of other issues and considerations (ex. if you owned another house during the period you rented out the first, if you moved out of the country etc.)

Best of Luck.


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## nobleea (Oct 11, 2013)

VideoTaxJoe said:


> Beaconhill - your intuition is correct. What the election does is to effectively change the date when the "change in use" to a rental property occurs for tax purposes (moving it up to 4 years later). This change date is the important part as it is the point when you would have a disposition. This means that the new cost base for the property is the value at the new "change in use" date. Your taxes owing would look like this:


Thanks for this, I had no idea. That sounds like a stupid loophole, I can see no benefit for it. It should be FMV when the house is first rented out, end of story.

beaconhill, where do you live now? a rented home, or one you own? If it's owned by you, then be sure you think about your residences as a whole, since you can have only one primary residence at one time.

For example, if you bought a house to live in 2005 when you moved, but you claimed the 4yr exemption on your rental, you would have to pay capital gains taxes on your second home from 2005 til the end of the 4yr exemption on the old place. So if the new house is pricier than the old one, you'd end up paying more.


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## VideoTaxJoe (Jun 24, 2015)

VideoTaxJoe said:


> Your taxes owing would look like this:
> 
> a) 2005-2014 increase in value completely eliminated if you designate it for the PRE and the 4 years election is granted (Income Tax Act Subsection 45(2))
> b) 2015 increase in value taxable as a capital gain (i.e. taxable at half your normal income tax rate)


Woops -sorry! I misread the timeline (thought the conversion to rental occurred in 2010 as opposed to 2005). In general, the tax on the gain is eliminated for the years that it can be normally designated as a PRE + the 4 years if eligible. Gains for the period after it expires would be taxable. (So this means, the method described by beaconhill in Example A is correct). 

Nobleea - The reason that this election is available is because the Government doesn't want to hit the taxpayer with a big bill if he/she hasn't sold the asset and generated cash flow to pay the bill. For one reason or the other, it is implied that this reasoning and concession should only be good for four years...and by the end of that time, the taxpayer should either move back into the house or come up with a solution to pay the bill.


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## nobleea (Oct 11, 2013)

VideoTaxJoe said:


> Nobleea - The reason that this election is available is because the Government doesn't want to hit the taxpayer with a big bill if he/she hasn't sold the asset and generated cash flow to pay the bill. For one reason or the other, it is implied that this reasoning and concession should only be good for four years...and by the end of that time, the taxpayer should either move back into the house or come up with a solution to pay the bill.


Yes, but by adding the 4 extra years are PRE, there is no bill. I can see maybe a delay in 4 years to pay the bill, but not an elimination of the bill. I guess it doesn't really matter since once can only make the PRE on one residence at a time, so it's not like they can double dip.


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## VideoTaxJoe (Jun 24, 2015)

Not going to argue with you there!


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## beaconhill (Oct 28, 2014)

VideoTaxJoe said:


> Beaconhill - your intuition is correct. What the election does is to effectively change the date when the "change in use" to a rental property occurs for tax purposes (moving it up to 4 years later). This change date is the important part as it is the point when you would have a disposition. This means that the new cost base for the property is the value at the new "change in use" date. Your taxes owing would look like this:
> 
> a) 2005-2014 increase in value completely eliminated if you designate it for the PRE and the 4 years election is granted (Income Tax Act Subsection 45(2))
> b) 2015 increase in value taxable as a capital gain (i.e. taxable at half your normal income tax rate)
> ...


Thank you very much. This could help me a great deal if the late election is allowed. Once I moved out of the house I rented. I did not deduct a CCA on my property, and I did not own another property that I claimed as a PR. I will have an accountant prepare my taxes.
Thanks again!


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## beaconhill (Oct 28, 2014)

No problem about the timeline. I understand the rules, which is the important part.


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## beaconhill (Oct 28, 2014)

It's hard to understand the reasoning behind the rule, but if people have to move from their home because of unforeseen circumstances, I guess it could help them.


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