It is not uncommon for former Canadian residents to retain and rent their personal residence when they emigrate, rather than selling it before they leave. As long as the property is rented on an arm’s length basis under terms that do not allow the expat to reoccupy on short notice, the retention of this property should not preclude the emigrant from being viewed as a non-resident[1]. In addition, in such situations, the former residence should not be viewed as being a “permanent home available” for the purposes of the “tie-breaker” rules typically found in Canada’s tax treaties[2].
Under such circumstances, there will be a number of Canadian tax reporting and compliance issues relating to the rental income generated from the property. These will be the same as those that apply to any situation in which non-residents earned income from renting Canadian real estate, and will not be reviewed in this article.
Rather, the focus of this article will be on the implications when the property is sold, in connection with Canadian tax liability on capital gains, particularly in relation to the application of the “principal residence exemption” (“PRE”).
Typically, in situations where the emigrant rents out his/her home, there would be a deemed disposition and reacquisition of that home at the fair market value under subparagraph 45(1)(a)(i) of the Income Tax Act (“the Act”). To the extent that was any accrued gain, it would normally be tax-exempt under the PRE, and this will establish a new deemed acquisition date and cost base.
The only way that this would not be the case would be if an election was filed under subsection 45(2) of the Act. If that were the case, there would be no deemed disposition and acquisition.
On a subsequent disposition of the property, the exempt gain under the PRE would be determined based on the following general formula[3]:
Exempt portion of gain= (P+1)/T
Where:
P=Number of years during which principal residence and resident in Canada
T=Total number of years during which owned
Most emigrants do not file the election. However, it would always be a good idea to make the election if the fair market value is less than the cost base (to avoid a step-down in cost base), or if there is very little accrued gain.
If the emigrant sells the property while non-resident, the gain will be subject to tax in Canada, and clearance and withholding issues under section 116 of the Act will apply.
Any gain exempt under the PRE would already be reflected in the cost base if no 45(2) election has been filed; if one has, it would be determined based on the formula indicated above.
The same will be true if the emigrant returns to Canada without reoccupying the residence, except that, in that case, section 116 will have no application.
What happens if the emigrant returns to Canada and reoccupies the residence?
In that case, unless the emigrant had filed the 45(2) election when he departed, there would generally be a deemed disposition and acquisition at fair market value.[4] This would result in the recognition of a capital gain equal to the excess (if any) of the fair market value at that time over the value at the time it was first used to earn rental income.
However, it would be possible to avoid that deemed disposition, and possible resulting capital gain, if an election is filed under subsection 45(3) of the Act. This election would only be available if:
- No capital cost allowance (“CCA”) has ever been claimed by the expat with respect to the property, and
- The property becomes the principal residence of the emigrant.
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If the 45(3) election is filed, and the property is subsequently sold, the PRE would generally be available based on the general formula outlined above, where “P” would be the number of years occupied after the return to Canada as a resident, and “T” would be the total number of years during which the property was owned, starting with the first year that it was used to earn income.
[1] Paragraph 1.12 of CRA Folio S5-F1-C1
[2] Ibid, paragraph 1.49
[3] Paragraph 40(2)(b) of the Act
[4] Subparagraph 45(1)(a)(ii). However, if a 45(2) election had previously been made, this provision should not apply because the property would always be viewed as a personal use property, and there would be no change in use.
ABOUT THE AUTHOR OF THIS ARTICLE
Michael I. Atlas, CPA,CA,CPA(ILL),TEP
Michael Atlas is one of the most prominent international tax experts in Canada. He advises accounting and law firms all across Canada, as well as select private clients (corporate and personal) worldwide. He can be reached by phone (416.860.9175) or email (matlas@TaxCA.com).