2024-1009501E5 MHRTC - PRE and Change in Use

Principal Issues: 1. Whether a partial change in use and deemed disposition pursuant to paragraph 45(1)(c) of the Act is considered to have occurred when a taxpayer undertakes a qualifying renovation to their eligible dwelling to create a secondary unit in accordance with the requirements of the MHRTC. 2. Whether a taxpayer’s secondary unit forms part of their principal residence for purposes of claiming the principal residence exemption pursuant to paragraph 40(2)(b) of the Act on a future disposition of their property. That is, whether the secondary unit (for instance, a basement suite or laneway home) and the primary residence are considered one housing unit of the taxpayer.

Position: Question of fact.

Reasons: 1. Whether a partial change in use and deemed disposition of a taxpayer’s property occurs (pursuant to paragraph 45(1)(c) of the Act) where a taxpayer makes a qualifying renovation to their eligible dwelling (which establishes a secondary unit) according to the requirements of the MHRTC, is question of fact and can only be made on a case-by-case basis, having regard to all the facts and circumstances of the particular taxpayer’s situation. However, since the MHRTC legislation in section 122.92 of the Act, does not impose any requirement on the taxpayer to use the secondary unit for rental or income earning purposes, and the use of the secondary unit is as a dwelling for a taxpayer’s family (that is, a qualifying individual or their qualifying relation), it is possible that in some circumstances the partial change in use rules in paragraph 45(1)(c) will not apply. 2. A taxpayer that constructs a secondary unit that is a self-contained housing unit according to the requirements of the MHRTC would generally be considered to have two separate housing units. Nonetheless, where a taxpayer uses the secondary unit for personal purposes rather than as a rental (that is, as a rental property that is a source of income for the taxpayer), and they are able to demonstrate that the two housing units are sufficiently integrated and are being used together and are functioning as one, then it may be possible to conclude that the entire property is one housing unit and as such, may be eligible for the PRE.

Author: Foggia, Christina
Section: 40(2)(b), 45(1), 45(2), 45(3), 54 - definition of principal residence, 118.3(1), 122.92

XXXXXXXXXX                                                                2024-100950
                                                                                        Christina Foggia, CPA CA

June 27, 2024

Dear XXXXXXXXXX:

Re: Multigenerational Home Renovation Tax Credit – Partial Change In Use and Principal Residence Exemption

This is in reply to your correspondence of February 25, 2024, concerning the multigenerational home renovation tax credit (“MHRTC”). More specifically, you asked about the partial change in use rules and the principal residence exemption (“PRE”) when a taxpayer constructs a secondary unit on their property according to the requirements of the MHRTC.

You explain that you would like to create a separate living space in the basement of your home (that is, a basement suite) for your adult son to live in. Your son is eligible for the disability tax credit provided by subsection 118.3(1) of the Act. The basement suite will afford each of you with some independence but at the same time will allow you to maintain close proximity to your son to provide additional support when needed. You indicate that the basement suite will occupy approximately 20% of your property, and in order to comply with local building codes and to qualify as a secondary dwelling unit, it will have its own separate entrance. Lastly, you mention that your son is on a limited income so you expect that any payments he makes for the use of the basement suite will be well below fair market value (“FMV”).

Our Comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (the “Act”) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

The MHRTC is a new 15% refundable tax credit which allows an eligible individual to claim up to $50,000 in qualifying expenditures that are paid and are directly attributable to a qualifying renovation that is made to an eligible dwelling of a qualifying individual (a senior or an adult child who is eligible for the disability tax credit in subsection 118.3(1) of the Act). (footnote 1)   A qualifying renovation means a renovation or alteration of, or addition to, an eligible dwelling of a qualifying individual, that is of an enduring nature and integral to the eligible dwelling. The renovation is undertaken to allow the qualifying individual and a qualifying relation of that individual to reside together in the dwelling, by establishing a secondary unit (that is, a self-contained unit with a private entrance, kitchen, bathroom facilities and sleeping area) within the dwelling for occupancy by the qualifying individual or the qualifying relation.

The MHRTC can be claimed for the tax year in which the renovation period for the qualifying renovation ends and is available for amounts paid for work performed or goods acquired after December 31, 2022. You can find additional discussion at the Canada Revenue Agency’s (“CRA”) webpage titled, Multigenerational home renovation tax credit (MHRTC) - Canada.ca. (footnote 2)

The CRA’s general views on claiming the PRE are set out in Income Tax Folio S1-F3-C2 “Principal Residence” (“PR Folio”). (footnote 3) Generally, if a property qualifies as a taxpayer’s principal residence, an exemption can be claimed under paragraph 40(2)(b) of the Act to reduce or eliminate any capital gain otherwise occurring for income tax purposes on the disposition (or deemed disposition) of the property. The term “principal residence” is defined in section 54 and includes, among other things, a property that is a housing unit or a leasehold interest in a housing unit that the taxpayer owned, whether jointly with another person or otherwise, and that was ordinarily inhabited in the year by the taxpayer, the taxpayer’s spouse or common-law partner, former spouse or common-law partner, or child. A taxpayer can designate only one property as their principal residence for a given tax year. Additionally, no other property can be designated as the principal residence of any member of the taxpayer’s family unit for the year. (footnote 4)  

Change in Use and Deemed Disposition

Where a taxpayer has partially converted a principal residence to (or from) an income-producing use, paragraph 45(1)(c) of the Act deems a disposition (and reacquisition) of that part of the property to have taken place (such portion is usually calculated on the basis of the area involved) for proceeds equal to its proportionate share of the property’s FMV. Any gain otherwise determined on the deemed disposition is usually eliminated or reduced by the PRE.

Paragraph 2.59 of the PR Folio explains that the CRA’s practice is not to apply this deemed disposition rule, but rather to consider that the entire property retains its nature as a principal residence, in circumstances where all of the following conditions are met:

a) the income-producing use is ancillary to the main use of the property as a residence;

b) there is no structural change to the property;

c) no CCA is claimed on the property.

The determination of whether there has been a structural change to a taxpayer’s property to make it more suitable for rental or business purposes requires a review of the particular facts in each case. However, where a taxpayer undertakes a renovation for the purpose of the conversion of a portion of a taxpayer’s principal residence into a separate, self-contained domestic establishment (housing unit) to be used for earning rental income, the partial change in use rules will generally apply (that is, the CRA’s administrative policy described above would not apply).

Whether a partial change in use and deemed disposition of a taxpayer’s property occurs where a taxpayer makes a qualifying renovation to their eligible dwelling (which establishes a secondary unit) according to the requirements of the MHRTC, is a question of fact and can only be made on a case-by-case basis, having regard to all the facts and circumstances of the taxpayer’s particular situation. However, since the MHRTC legislation in section 122.92 of the Act does not impose any requirement on the taxpayer to use the secondary unit for rental or other income earning purposes, and the use of the secondary unit is as a dwelling for a qualifying individual (or their qualifying relation), it is possible that in some situations, the partial change in use rules in paragraph 45(1)(c) of the Act will not apply. That is, depending on the circumstances, the taxpayer may not be considered to have changed the use of their property to an income earning purpose, and as such, a deemed disposition and partial change in use would not occur for income tax purposes.

Principal Residence Exemption

As previously noted, the term “principal residence” means, among other things, a property that is a housing unit. The term housing unit is not defined in the Act; however, the term has been broadly defined in jurisprudence and is discussed in paragraph 2.7 of the PR Folio, which explains that a housing unit can include a house; an apartment or a unit in a duplex, apartment building, or a condominium; a cottage; a mobile home; a trailer; or a houseboat.

Whether a property containing more than one separate self-contained domestic establishment (housing unit) is considered one or two housing units for purposes of the principal residence definition in section 54 of the Act is a question of fact that can only be determined following a review of all of the specific facts and circumstances of a taxpayer’s particular situation. Factors to be considered in the determination of whether a taxpayer has one or two housing units in a given situation, include, but are not limited to, the extent of integration of the two units, whether or not the units have separate legal titles, separate municipal addresses, separate entrance doors, and separate accounts for utilities and other public service providers, as well as the use of the units.  

In general, if two housing units can be enjoyed and ordinarily inhabited separate from each other without access to the other (that is, if each unit is a self-contained unit with its own entrance, kitchen and bathroom), it is our view they will generally be considered separate housing units for purposes of the PRE. This may be the case notwithstanding the fact that the housing units are part of a single structure or are not on separate legal lots.   Accordingly, only one unit will be eligible for designation as the taxpayer’s principal residence for any particular year. An exception to this general view might apply in a situation where it can be demonstrated that the two units are sufficiently integrated (both structurally and usage) and as such, are being used for the exclusive use and enjoyment of the taxpayer and their family (that is, the two units are being used together and are functioning as one single family residence).

Accordingly, a taxpayer that constructs a secondary unit that is a self-contained housing unit according to the requirements of the MHRTC would generally be considered to have two separate housing units. Nonetheless, where a taxpayer uses the secondary unit for personal purposes rather than for the purpose of gaining or producing income (for instance, as a rental property that generates a source of income for the taxpayer), and they are able to demonstrate that the two housing units are sufficiently integrated and are being used together and are functioning as one, then it may be possible to conclude that the entire property is one housing unit that is entirely eligible for the PRE.

We trust our comments will be of assistance.

Yours truly,

Pamela Burnley CPA, CA
Manager
Business and Capital Transactions Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 A qualifying individual is defined in subsection 122.92(1) of the Act as an individual who is 65 years of age or older at the end of the renovation period taxation year or an individual who is 18 years of age or older at the end of the renovation period taxation year who is eligible for the disability tax credit.

2 Available at: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/multigenerational-home-renovation.html

3 https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-1-individuals/folio-3-family-unit-issues/income-tax-folio-s1-f3-c2-principal-residence.html

4 Refer to paragraph 2.13 of the PR Folio for explanation of the phrase “family unit.”

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