Can subsection 45(3) of the ITA be applied at the time of the change in use of a house that has been used as rental property for more than 4 years?

For the purpose of this blog, in 2015 Arnaud bought a house in Canada to generate rental income. In 2023, he decides to move in and the house became his principal residence. In 2025, he sold his house and realized a capital gain.

What must Arnaud do in 2023 at the time of the change in use, and what must he do in 2025 at the time of the disposition of his house, in order to benefit from the 4 years of exemptions according to paragraph 45(3)?

Yes, subsection 45(3) of the Income Tax Act (ITA) can be applied at the time of the change in use of a house that has been used as rental property for more than 4 years, provided certain conditions are met. Here is what Arnaud must do in 2023 at the time of the change in use, and in 2025 at the time of the disposition of his house, to benefit from the 4 years of exemptions according to subsection 45(3):

2023: Change in Use

Election under Subsection 45(3)

Arnaud must file an election under subsection 45(3) of the ITA to defer the deemed disposition that would otherwise occur when the property changes from an income-producing use to a principal residence. This election must be made by means of a letter signed by Arnaud and filed with his income tax return for the year in which the change in use occurs (2023).

Conditions for the Election

No Capital Cost Allowance (CCA) Claimed: Arnaud must ensure that no CCA has been claimed on the property for any taxation year ending after 1984 and on or before the change in use.

Principal Residence: The property must become Arnaud’s principal residence, meaning it must be ordinarily inhabited by him or a member of his family unit (spouse, common-law partner, or child).

Documentation

Arnaud should keep records of the fair market value of the property at the time of the change in use, although a formal valuation is not required if the election under subsection 45(3) is made.

2025: Disposition of the House

Reporting the Sale

When Arnaud sells the house in 2025, he must report the sale on his income tax return for that year. The capital gain will be calculated based on the Adjusted Cost Base (ACB) of the property, and the proceeds of disposition in 2025.

Principal Residence Exemption

Arnaud can designate the property as his principal residence for up to 4 years prior to the change in use, even if he did not actually live in it during those years, provided he was resident or deemed to be resident in Canada during those years.

To calculate the principal residence exemption, Arnaud will have 2 years of exemption from 2023 to 2025, plus the 4 years preceding 2023 according to 45(3), plus the extra one year. The principal residence exemption is then equal to seven tenth (7/10).

He must ensure that no other property was designated as a principal residence by him or a member of his family unit for those years.

Filing the Election

Arnaud must include a letter with his 2025 income tax return confirming the election under subsection 45(3) and providing details of the change in use and the sale.

Summary of Steps

2023: File the election under subsection 45(3) with the income tax return, ensuring no CCA was claimed and the property becomes the principal residence.

2025: Report the sale, designate the property as the principal residence for up to 4 years prior to the change in use, and include a letter confirming the election and details of the sale.

By following these steps, Arnaud can benefit from the 4 years of exemptions according to subsection 45(3) of the ITA.