What Is It?
When you change the use of a property — for example, converting your principal residence into a rental or converting a rental into your home — the Income Tax Act (s. 45) deems you to have disposed of the property at fair market value and immediately reacquired it. This deemed disposition triggers capital gains tax on any appreciation up to the date of the change.
The s.45(2) election allows you to defer this deemed disposition by electing to treat the property as still used “as a principal residence” for up to 4 years after the change in use, even if you are not actually living in it. This means you can designate the property as your principal residence for those years and shelter the accumulated gain under the principal residence exemption.
When This Applies
Common scenario 1: You own your home, move out to rent elsewhere or move abroad, and start renting out your former home. Without the election, a deemed disposition occurs at fair market value when the rental use begins. With the election, you can defer the deemed disposition and designate the property as your principal residence for up to 4 additional years.
Common scenario 2: You buy a property as an investment rental and later move in to make it your principal residence. A deemed disposition occurs at fair market value when personal use begins. You can then designate the property as your principal residence going forward, sheltering future gains.
The S.45(2) Election — Converting to Rental
If you convert your principal residence to a rental property and make the s.45(2) election:
- No deemed disposition occurs at the time of change in use
- You can continue designating the property as your principal residence for up to 4 years after the year you moved out
- You cannot claim CCA (capital cost allowance/depreciation) on the property during the election period — claiming CCA cancels the election
- When you eventually sell, you calculate the principal residence exemption using the full number of years designated, including the rental years
The S.45(3) Election — Converting to Principal Residence
If you move into a rental property and make the s.45(3) election:
- The deemed disposition is deferred until the actual sale
- You can retroactively designate the property as your principal residence for up to 4 years before you moved in (back-designation)
- This allows years of rental use to be sheltered under the principal residence exemption if no other property was designated in those years
What Most People Don’t Know
- You cannot claim CCA while the s.45(2) election is in effect. Many landlords claim depreciation on their rental property — doing so cancels the election retroactively. If you plan to claim CCA, you cannot preserve the election. This is a critical trap.
- The 4-year extension can be extended further for employment relocations. If you move out due to a requirement to relocate for your employer (more than 40 km from your home), the 4-year limit can be extended indefinitely as long as you continue to meet the relocation conditions.
- You must file the election by the due date of the return for the year of the change in use. The s.45(2) election is made by filing a letter with your tax return for the year the change occurs — if you miss this, you may be able to file a late election, but penalties may apply.
- The election shelters the gain but doesn’t eliminate reporting. You still report the eventual sale and calculate the exemption properly using form T2091 (Principal Residence Designation).
Frequently Asked Questions
I moved out in 2020 and didn’t know about this election. Can I still file it?
Possibly — the CRA allows late-filed s.45(2) elections with a penalty of $100/month (up to $8,000 maximum). File the election letter as soon as you become aware of the requirement; the sooner you file, the smaller the penalty.
I’ve been renting my former home for 6 years. Can I still use the election?
The election is still available, but you can only designate the property as a principal residence for a maximum of 4 years after the year you moved out (plus the year of the change). The remaining years of rental use will be proportionally subject to capital gains tax based on the ratio of non-designated years to total years of ownership.
My spouse and I both own properties we each lived in. Can we both use the election?
A married couple (or common-law partners) can only designate one property per year as a principal residence. If you both owned separate properties and each claim the exemption for overlapping years, only one can be the “family unit” principal residence per year. Plan carefully.
What happens if I sell the property while the s.45(2) election is in place?
When you sell, you calculate the principal residence exemption using the formula: (1 + years designated ÷ years owned) × gain. The designated years include the rental years covered by the election. Report the sale on your T1 and attach form T2091.