Election 45(2) Rental Property

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SM
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Joined: Fri Mar 20, 2015 3:43 pm

Election 45(2) Rental Property

Post by SM »

Does anyone know the intricacies of filing election 45(2) upon departure? I understand that if you sell your home within one year of emigrating Canada you will pay no tax at all because of the PRE bonus year (assuming you don’t rent it out). However, if you start renting your property on the day you emigrate Canada, you’re deemed to sell the property (“change in useâ€￾). You then need to get an appraisal done and any future growth is taxed in Canada and the US when you ultimately sell the property. In other words, you don’t get the bonus year if you decide to rent it out.

I’ve heard there is a way to limit the tax on the future growth of the rental property by filing election 45(2), but I'm not sure why? I think it’s because it gives you the extra bonus year that you would normally only get if you don’t rent the property? This election deems the “change-in-useâ€￾ not to take place and allows you to claim an extra 4 years as your principal residence even know you have rented out the property. However, you only get the bonus for any given year if you are a resident of Canada at some point during that year.

If the accrued gains on the property at the time of departure are large, it seems like a gamble just to save tax on the potential future growth. If the property increases significantly during the first year after departing AND you sell the property within one year of departure, I suppose the election makes sense and you have nothing to lose (you save yourself a year of gains and don’t pay tax on any of the gains that accrued while you were a resident).

However, if you sell the property AFTER one year, the accrued growth while you were a resident will now be taxed proportionately when you sell the property (not just the growth from the time you departed, like it would be if you didn’t file the election and just let the deemed “change in useâ€￾ take place). In other words, you MAY have been better off not using the election on departure and just using the PRE (eliminate all tax up to that point). It will all depend on the size of the accrued gains at departure and the future growth after departure. Furthermore, if the property value remains flat or decreases after you depart AND you sell the property AFTER one year; the election actually hurts you (because you now have to pay a proportionate amount of tax on the gains that accrued while you were a resident).

In summary, I suppose if you sell within one year of departure, OR if there are NO accumulated gains at the time of departure you have nothing to lose. You guarantee yourself one extra year of tax free gains and never have to worry about being taxed on the accumulated gains while you were a resident. Otherwise it’s a gamble… Am I overlooking anything?

I have also heard that CRA will accept late filed 45(2) elections as long as no CCA has been claimed on the property and you pay the late filing penalty. If this is the case, why wouldn't everyone just wait to see if the value increases after departure and late file the election in the year of sale if it benefits them?
nelsona
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Post by nelsona »

It is not the case that you "lose" the one year Bonus, as long as you do not use CCA on the property.
There is no need to use change of use, since you are simply not allowed to use PRE once you become a non-resident.

The change of use scheme doesn't work for non-residents.

If you really want to be only taxed on post-departure gains, then what you do is elect to have deemed sold the property, Form T2601A using 128.1 . That is NOT the same as the change in use 45(2)

In practice, when you sell, you will be able to choose, even if you do not file T2061A, the better of the post-departure gains, or the PRE + 1 method as long as you don't CCA.

Trouble is, most people moving to US end up CCAing the rental property because they have to in US anyways, and it melds the taxes better.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
SM
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Post by SM »

My understanding is the “change in useâ€￾ is NOT optional, it must occur. It’s a deemed disposition just the same as if you die, emigrate, or gift property, etc. The 45(2) election is the optional part. Let’s take the departure out of the equation for a minute. If this was optional, everyone that ever changed their principal residence into a rental property would get a free year of growth on the rental property. Compare this to the individual that buys a rental property and rents it from day one (never using it as a principal residence). In this case, he’s taxed on the first year of growth and the individual that used it as a principal residence first is not.

http://www.cra-arc.gc.ca/tx/ndvdls/tpcs ... u-eng.html

My understanding of form T2061A is it’s not needed if you are changing the use of the property to a rental at the time of departure. When you change the use, the property is deemed to be sold (change in use rules); and the form becomes redundant. It wouldn't hurt you to file it anyway, but I din't think it was necessary in this specific case. As you know, the other common times to use this form would be 1) You have a principal residence that you want to deem to be sold (which normally wouldn't be beneficial) or 2) You have an existing rental property that is in a loss position and you want to use the loss to offset other departure gains.

If the “change in useâ€￾ is NOT optional, then you must lose the bonus year. You would have to use the PRE on your departure return to offset the gains on the “change in useâ€￾ disposition. This would be your new starting point, you would have to get an appraisal of the property and all future gains from that point forward would be taxable when you sell as non-resident. You wouldn’t be able to use the PRE again when you sell because it’s now a rental property. If the change in use is not mandatory, then yes I agree with you 100%.

You brought up an excellent point about most people claiming the CCA to match the depreciation you are forced to use on the US side. I never thought about this aspect of it before. This may be one more reason not to use election 45(2). If you claim CCA, this election is deemed to be revoked and the property is deemed to be sold; forcing you to comply with S.116 and get a certificate of compliance T2062, etc. So if you file this election and don’t claim CCA, you will have a timing miss match for foreign tax credit purposes.

Any further insight on this would be greatly appreciated. I always thought a change in use was mandatory.
nelsona
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Post by nelsona »

I didn't say change of use doesn;'t occur, I said the change comes from a different part of the tax code.
I know of no one that has lost the bonus year after selling as a non-resident. whether they rented out or not. It is a unique situation for non-residents.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
SM
Posts: 94
Joined: Fri Mar 20, 2015 3:43 pm

Post by SM »

Hmm interesting... Thanks so much for your insight on this. That's great if that's the way it actually works in practice, but I'm not sure that's the way CRA intends it to work; unless I'm not understanding this correctly. See the excerpt below from Ernst and Young's 2014 Guide to Preparing Tax Returns Chapter 10: Taxation of immigrants, emigrants and non-residents.

Change in use to rental property
If an individual retains rather than sells a Canadian home, a capital gain or loss does not arise under the departure tax rules, as the home (as real property) constitutes one of the properties that is exempt from the deemed disposition (departure tax) provisions. However, if an individual rents out a former principal residence during a period of absence from Canada, a change in use of the property occurs (resulting in a deemed disposition and immediate reacquisition at fair market value). All or part of the gain resulting from this deemed disposition may be exempt from Canadian tax under the principal residence exemption rules. If the individual subsequently reoccupies the home, the change-in-use rules apply again at that time, resulting in a second deemed disposition and reacquisition at fair market value. If the property has appreciated in value, the second deemed disposition results in a tax liability because the principal residence exemption does not apply to the rental period.

The deemed disposition and reacquisition may be avoided if the individual elects that no change in use has occurred (i.e., despite the fact that the property is rented, it continues to be regarded as a principal residence for tax purposes). The election is made by simply enclosing a signed statement to this effect in the individual's T1 return for the year during which the individual starts renting the property. The election is effective until it is revoked by the individual (see discussion below under Revoking a 45(2) election as a non-resident).

Making a 45(2) election as a non-resident
Both residents and non-residents may make a 45(2) election.115 However, the interaction of the principal residence rules (which require an individual to be a resident of Canada to obtain the maximum exemption) and the 45(2) election can create an interesting dilemma or opportunity for an individual.

An individual may want to consider the benefits of NOT making a 45(2) election if
• the individual is planning to become a non-resident of Canada;
• the individual is planning to rent his or her former home as a non-resident of Canada;
• the individual is planning to sell the property as a non-resident;
• there have been significant accrued gains in the value of the property from the time of acquisition to the time of departure from Canada; and
• the individual anticipates there will be very little increase in the value of the property while he or she is a non-resident.

If the individual does not make the 45(2) election, there is a deemed disposition of the property at the time of the change in use. Assuming all the gain to the date of departure is sheltered by the principal residence exemption, no tax arises as a result of the deemed disposition. Any subsequent gain realized after departure from Canada is subject to Canadian tax; however, if there is no increase in the value of the property after departure from Canada, there is no Canadian tax to pay when the property is disposed of. In contrast, if the individual makes a 45(2) election, there is no deemed disposition resulting from a change in use at the time of departure from Canada. Therefore, if the property is sold after the first year as a nonresident, a portion of the total gain on the property from the time of original purchase to the time of sale is subject to Canadian tax. The amount of the gain subject to tax depends on the average annual gain over the entire time the property was held, the number of years the property was owned, and the number of years the owner was a non-resident of Canada. Inherent in this approach is the risk that the individual will still own the property and will repatriate to Canada to reoccupy the home as a residence, and the property will have increased in value while the individual was a non-resident. If the individual has claimed capital cost allowance in determining the amount of rental income subject to tax in Canada and, as a consequence, is not allowed to make a 45(3) election on repatriation to Canada, a deemed disposition of the property would occur upon the individual's return to Canada if the property is again occupied as the individual's home. Any gain that has accrued while the owner was a non-resident will then be subject to tax.
nelsona
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Post by nelsona »

This info is only useful for those who return to Canada with a property that they held before leaving.
Otherwise, the rules I described earlier ALWAYS apply. One ALWAYS gets a year extra tax-free OR can choose the FMV at departure to calculate taxable gains. This holds true whether they rent it out or not.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
SM
Posts: 94
Joined: Fri Mar 20, 2015 3:43 pm

Post by SM »

Ok thanks again for you insight. I really do appreciate you taking the time to look this over. I thought this logic should be applicable to this situation as well, but maybe not. Especially the part that says "If the individual does not make the 45(2) election, there is a deemed disposition of the property at the time of the change in use. Assuming all the gain to the date of departure is sheltered by the principal residence exemption, no tax arises as a result of the deemed disposition. Any subsequent gain realized after departure from Canada is subject to Canadian tax". This part has nothing to do with returning to Canada. Furthermore, I'm not convinced that a deemed disposition resulting from a return to Canada is any different than an actual disposition when you sell it. A disposition is a disposition. I feel like in both cases the calculation should be the exact same.

My interpretation of all this is you only get the bonus year if you never rent out the property at all or if you file the 45(2) election on departure.

In any event, I was just trying to get another opinion on this and thank you for hearing me out. I spent hours researching this and could not find one definitive example given by any credible source that actually shows how this exact situation is calculated. Any sources that you are aware of that provide this sort of example?
FZ
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Joined: Wed Nov 04, 2015 3:06 pm

Post by FZ »

So there is no difference regardless if you file a 45 (2) election as far as CRA is concerned? I thought once you file a 45(2) election you have no disposition therefore you have to use the PRE formula 1+ years designated / no of years owned
If you dont elect into deemed disposition upon departure there is no disposition so the 45(2) election remains in effect

CRA doesnt care if you dont elect into the deemed disposition on departure from Canada?
FZ
Posts: 2
Joined: Wed Nov 04, 2015 3:06 pm

Post by FZ »

Continued

you can declare post departure gains and fmv at time of departure as ACB or PRE formula?
CRA doesnt care?
meithcnul00
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Joined: Mon Aug 28, 2017 3:29 pm

Post by meithcnul00 »

Hello there,

If the property was your principal residence prior to the change of use, you don’t have to pay tax on any accrued gain. In the past, it was the CRA’s administrative policy that when you disposed of your principal residence, you didn’t have to report the sale on your tax return if were eligible for the full PRE. But, as announced earlier this month, starting this year, you must report the sale and designation of the principal residence on Schedule 3, Capital Gains of your return to be eligible for the PRE. On the soon-to-be modified Schedule 3, you will need to report basic information such as the date of acquisition of the residence, a description of the property and the proceeds of disposition.

The good news, however, is that when you change your principal residence to a rental property, you may be able to make a special tax election not to be considered as having started to use your principal residence as a rental property and thus, you can avoid reporting this gain in the year of the change in use.

http://letzoo.co.uk/dss-properties-london.php

Thanks
nelsona
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Joined: Wed Oct 27, 2004 2:33 pm
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Post by nelsona »

As pointed ourt earlier in this thread, 45(2) does not apply to emigrants, and non-residents
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
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