There are several reasons an individual might convert part of their home into a rental property. However, this action can have significant income tax implications, including potentially limiting access to the principal residence exemption, which can be easily overlooked.

Two June 27, 2024 Technical Interpretations analyzed the tax implications of creating secondary suites. The suites reviewed in one interpretation were eligible for provincial program that provided forgivable loans, while the suite in the other interpretation qualified for the multigenerational home renovation tax credit.

Provincial program – forgivable loan

The program (BC Secondary suite incentive program) offers a forgivable loan to homeowners who create a new secondary suite or accessory dwelling unit on the property of their principal residence. For this particular program, the loan would be forgivable if the suite is rented at below-market rates for at least five years. The secondary suite must be a newly constructed legal self-contained unit and could include secondary suites attached to the primary residence (e.g. basement suites) or detached secondary suites (e.g. laneway homes and garden suites). Participants must enter into a rental agreement with a tenant who is not an immediate family member. Similar programs may be offered in other provinces and jurisdictions.

Source of income

CRA opined that the rent received would likely be a source of property income. The actual rent would be reported and not adjusted to fair market value. CRA noted that it was possible, depending on all facts and circumstances, that the activity would not be a source of income, in which case any losses would not be deductible.

Treatment of forgivable loan

The forgivable loan would generally be government assistance and result in a reduction of the cost of the secondary suite.

Change of use

CRA noted that a taxpayer who has partially converted their principal residence to an income-producing use would be deemed to dispose of (and reacquire) that part of the property for proceeds equal to its proportionate share of the property’s fair market value. Any resulting capital gain may be eliminated or reduced by the principal residence exemption.

CRA referred to their policy not to apply the deemed disposition provision in certain cases where a principal residence is also used to generate income but opined that the creation of a second housing unit as required for the provincial program would be a structural change, and therefore the deemed disposition provision would apply.

CRA confirmed that an election to avoid the deemed disposition could be filed. In this case, the deemed disposition would be avoided; however, CCA could not be claimed against the rental income.

Multigenerational home renovation tax credit (MHRTC)

The MHRTC provides tax credits for homeowners who renovate their homes to create a secondary unit for a qualifying individual (a senior or an adult eligible for the disability tax credit). The secondary unit must be self-contained with a private entrance, kitchen, bathroom and sleeping area and must meet local standards to qualify as a secondary unit.

Change of use

Whether a deemed disposition occurs upon partial change in use is a question of fact. Since the MHRTC does not require the secondary unit to generate rental income, and the unit would be used by a family member, there may not have been a change in use to gaining or producing income (from personal use). As such, the partial change in use rules may not apply.

Principal residence exemption (PRE) for secondary suites

Both interpretations discussed how secondary suites affect the PRE. If two units are each self-contained, each with its own entrance, kitchen and bathroom and can be ordinarily inhabited separate from each other (that is, without access to the other unit), CRA’s view is that they will generally be considered separate housing units for the PRE. Where it can be demonstrated that the two units are sufficiently integrated (both structurally and in their usage) and are being used for the exclusive use and enjoyment of the taxpayer and their family (that is, the two units are integrated to function as one single-family residence), it is possible that they would be a single housing unit.

In discussing the provincial program, CRA noted that the secondary suite would be a separate housing unit for PRE purposes. Even if it is part of the same structure or lot as the main home, only one unit could be designated as the principal residence each year. Since the suite must be rented to a non-family member to qualify for the program, it would not typically be inhabited by the homeowner, so it would likely not qualify for the PRE. However, the main residence could still qualify if it meets the usual requirements.

In the context of the MHRTC, CRA indicated that a taxpayer who constructs a secondary unit that is a self-contained housing unit eligible for the MHRTC would generally be considered to have two separate housing units. However, where the second unit is used for personal purposes and the taxpayer can demonstrate that the two units are being used together and functioning as a single unit, it may be possible to treat the property as a single unit eligible for the PRE. The determination of whether there are two self-contained housing units would be fact-dependent, as discussed above. Key factors would include the extent of the integration between the units and whether they share legal titles, mailing addresses, entrance doors and utility accounts.

ACTION: Adding a secondary unit to a home may trigger a taxable disposition or limit the principal residence exemption. Assess tax implications before starting renovations.