Converting a Personal Property Into an Income Property

'Maybe you are in a similar situation as many investors and you're converting a personal property into an income property. Your current home no longer meets your needs for whatever reason, but it would be a great rental property. Instead of selling the home, you decide to take the equity out of the home to purchase your new primary residence, and keep the original property as an income property.

There are a few reasons you may want to do this:

• You already own a great home in a desirable neighbourhood that has all of the traits of a good rental property. This saves you from having to search for another property.
• Real estate is a valuable asset, and with a hot market it can make a lot of sense to continue holding onto a property if you know you can get monthly cash flow from the home.
• It’s less work to just buy one house instead of having to sell your current home and then purchasing your new principal residence PLUS an invest property.

Whatever your reason for converting your personal property into an income property, there are a few things you will want to know.

The Interest on the Mortgage Will Not be Tax Deductible 

The interest on mortgages obtained for investment properties is tax deductible. However, if you’re taking out a loan to purchase a new principal residence against what will be the investment property (your original property), the interest on that loan will not be tax deductible. While simplified, that’s because the interest is only tax deductible if:

1. The interest was paid or payable in the year in accordance with a legal obligation.
2. The borrowed funds were used for the purpose of earning income from a business or property – the term “property” referring to interest income, dividends, rents and royalties but not capital gains.

Converting a Personal Property Into an Income Property: You’re Changing the Use of the Property

The moment a property stops being your primary residence and becomes an income property, you need to get an appraisal. That’s because the use of the property changes.

Canada Revenue Agency (CRA) regulates when and how to change the use of your property. Every time you change the use of your property, it becomes valued at fair market value. Any appreciation from the date it stops being your primary residence and becomes an income property would be considered capital gain.

You don’t have to pay taxes on the appreciation value that occurred over the years the home was your primary residence, but when you eventually sell the property you will have to pay tax on the capital gain seen over the years that the property functioned as an income property. That’s why you want to make sure that you have your home appraised before making changing its use to an income property.

The same thing holds true if you add an income suite to your home. As soon as a portion of your home is used to generate income, you will need to assess the value of your home. Then the percentage of the capital gain of your home used for income will be subjected to taxation when you sell.

You do not have to change the use of your home if:

1. The portion of the property used as a rental or rental or for business use is relatively small in comparison to the rest of the principal dwelling.
2. No structural changes are made for the purpose of making the space more suitable for generating income.
3. You cannot deduct any capital cost allowance (CCA) on the portion of the property used to generate income.

If all three conditions are met you don't have to make any changes to the use of your home. However, if these conditions aren’t met, and you have to change the use of your home, you will have to split the selling price of the home based on square metres or the number of rooms in the house and pay tax on that percentage of the capital gain.

Maybe you have to move for work and you don’t want to sell your current house because you intend to eventually move back, and you’d prefer renting it out for the time being. Well, I have some good news for you. You don’t necessarily have to change the use of your home.

You can make an election to extend the use of your home as your principal residence, even if youre using it as a rental or as a business property. By doing this you won’t have to report any capital gain or pay tax on that capital gain over this period of time. With this election, you can claim principal residence as the use of the property up to four years regardless of its use. However, if you make this election you have to:

1. Report the net income generated for the property during this time.
2. You cannot declare capital cost allowance (CCA) on the property.
3. You cannot have any other properties listed as your principal residence during this time.

If four years is not enough time, you can extend this time indefinitely as long as you:

• Relocated because your employer, or your spouse’s employer, wants you to relocate.
• You, or your spouse, are not related to the employer who is asking you to move.
• Your principal residence is more than 40 kilometres (by shortest public route) from your (or your spouse’s) new place of employment.
• You move back to your principal residence before the end of the year following the end of the employment that required you to relocate.

If you can no longer live in your home and it would be a good rental property then it may make a lot of sense to hold on to it. Just know that there is more work involved than just renting it out. Just like you would when buying a new investment property, always consult with a real estate accountant (we're not accountants!) for proper tax advice before converting a personal property into an income property.

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