Convert Primary Residence to Rental Tax Guide
Convert Primary Residence to Rental Property: Tax Rules & Next Steps
You’ve outgrown your starter home, but instead of selling, you’re thinking of keeping it as an investment. This is a powerful wealth-building move, but it is one of the most complex decisions under Canadian tax law. The moment you convert your primary residence to rental property, the CRA considers it a “Change in Use,” which has significant tax implications you must address immediately.
Phase 1: The Tax Reality (CRA Change in Use)
The Capital Gains “Time Bomb”
- The Problem: The principal residence exemption protects you from paying capital gains tax when you sell your home. When you start renting it out, that exemption ends on that portion of the home.
- The Change in Use: The CRA deems you to have sold the property to yourself at fair market value on the day it became a rental. This establishes the “cost base” for future capital gains calculations.
The Section 45(2) Election (CRA’s Lifeline)
You can avoid the immediate tax consequence (the deemed sale) by filing the CRA Section 45(2) Election.
- What it Does: This election allows you to defer capital gains tax for up to four years after you move out, allowing you to treat the property as your principal residence for tax purposes, even while it’s rented.
- Crucial Note: You can only file this if you haven’t claimed Capital Cost Allowance (depreciation) on the property.
Phase 2: Finance and Legal Requirements
Mortgage and Insurance Changes
- Mortgage: You are required to inform your lender that the property’s use has changed. Your lender may require you to sign a new mortgage contract (a “rental property” mortgage) or purchase rental-specific insurance, as the risk profile is different.
- Insurance: You must switch from standard homeowner’s insurance to a Landlord/Rental Property Insurance policy. Failure to do so will void your insurance if a tenant causes damage.
Phase 3: The Income Tax Impact
Income Tax on Rental Property Canada
- Reporting Income: All rental income must be reported.
- Deductible Expenses: The good news is that you can deduct expenses against that income, including a portion of your property tax, maintenance costs, utilities (if included), and insurance.
Keeping your first home as a rental is a powerful step toward building a real estate portfolio. However, you must manage the change of use tax rules CRA carefully. Speak to a specialized accountant before you convert and consult with your trusted realtor to ensure you maximize your tax benefits and asset growth.
Converting to a Rental FAQs
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Do I have to pay capital gains when I rent out my primary residence?
You don’t have to pay immediately if you file the Section 45(2) election, but you will owe capital gains on the profit accrued from the date of conversion to the date of sale.
Can I use the Section 45(2) election indefinitely?
No. You can only use the election for a maximum of four years, unless the reason for the move is work-related, in which case it may be extended.
What is the most common mistake when converting a home to a rental?
The most common mistake is failing to inform the insurance provider, which leaves the homeowner completely exposed to liability and property damage risk.
