What Happens When You Convert Your Principal Residence Into a Rental Property?
Thinking about turning your home into a rental? Whether you’re moving for work, upgrading to a new home, or simply testing out the rental market, the moment you change the use of your property from personal to income-producing, the Canada Revenue Agency (CRA) considers it a taxable event — but there are smart ways to manage it.
Is It a Taxable Event?
Yes — when you convert your principal residence into a rental property, the Income Tax Act deems you to have sold (disposed of) your home at its fair market value (FMV) and immediately repurchased it at that same value.
This is known as a deemed disposition, and it can trigger a capital gain if the property has increased in value since you bought it.
The Tax Impact
The capital gain is the difference between your home’s original purchase price and its fair market value at the time you convert it to a rental. However, if the property qualified as your principal residence for the years you lived in it, you may be able to use the principal residence exemption to reduce or completely eliminate the taxable portion of that gain.
Example: How It Works in Practice
Let’s take an example:
Bob bought his home in 2010 for $400,000 and lived in it as his principal residence. In 2025, he moves to another province for a new job but decides to rent out the home instead of selling it. The fair market value of the property at that time is $700,000.
When Bob files his 2025 tax return, he faces a deemed capital gain of $300,000 ($700,000 – $400,000). Thankfully, because it was his principal residence up to that point, he can use the principal residence exemption to shelter that gain.
The Future Tax Trap
Now, let’s fast forward. If Bob later sells the house in 2029 (or moves back in that year), the increase in value from 2025 to 2029 would be taxable, since that period represents years when the property was generating rental income.
How to Avoid Immediate Tax: The Subsection 45(2) Election
The good news? There’s a tax deferral option available — the Subsection 45(2) Election under the Income Tax Act.
This election allows homeowners to defer the deemed disposition and avoid triggering capital gains when converting their home into a rental.
Key Benefits of the 45(2) Election:
No capital gain is recognized at the time of conversion.
You must not claim Capital Cost Allowance (CCA) on the property while the election is active.
You must continue reporting rental income every year.
You can still designate the property as your principal residence for up to four years while it’s being rented — even if you’re not living there — provided you don’t claim another home as your principal residence during that period.
Example of the Election in Action
Returning to Bob’s case — if he files the 45(2) election in 2025, he can continue to treat his property as his principal residence for up to four years (2026 to 2029).
That means, if he sells or moves back into the home in 2029, any capital gain accrued during those rental years won’t be taxed.
Final Thoughts
Converting a home into a rental property comes with significant tax implications, but with the right election and planning, you can defer tax and preserve your principal residence status.
However, these rules can be complex, and the CRA has specific reporting requirements to ensure compliance. Always consult a qualified tax advisor or CPA before making the switch.
Disclaimer: This post is for informational purposes only and should not be considered tax advice. Always consult your advisor for personalized guidance.
