ImmoMulti — direct buyer of income properties on the North Shore — regularly meets owners surprised to learn they may owe tax on an income property they have not sold. The cause: a change of use. When you turn your principal residence into a rental property, or the reverse, the Canada Revenue Agency (CRA) and Revenu Québec consider that you have disposed of the property at its fair market value, then reacquired it at the same amount. This "deemed disposition" can trigger a taxable capital gain — with no actual sale and no money received. Fortunately, two tax elections (subsections 45(2) and 45(3)) let you defer that tax. Here is how these rules apply, especially for a plex owner-occupant.
What is a change of use for tax purposes?
A change of use occurs when you stop using a property one way and start using it another way: turning your principal residence into a rental property, or turning a rental property into your principal residence. For tax purposes, this change is treated like a sale — the "deemed disposition."
For tax purposes, a property's use determines its treatment. A principal residence benefits from a capital gains exemption, while a rental or income property is a property used to earn income, whose gain is taxable on disposition. When you move a property from one category to the other, the tax authorities consider that a taxable event occurs — even though you remain the owner.
According to Revenu Québec, a change of use happens notably when you start renting out a property you were living in, or when you move into a property you were renting out. This is extremely common among plex owners: keeping a former unit to rent after moving out, or taking back a rented unit to live in it yourself.
Source: Revenu Québec — Renting Out a Residence (Change of Use).
Why does a change of use trigger a deemed disposition?
On a change of use, you are deemed to have disposed of the property at its fair market value (FMV), then to have reacquired it immediately at the same amount. This deemed disposition can crystallize a capital gain for the year of the change of use — with no actual sale having taken place.
The mechanism is the same at the CRA and Revenu Québec: at the moment of the change of use, you are deemed to have disposed of the property at its fair market value, then to have reacquired it immediately at the same amount. This value becomes your new tax cost (adjusted cost base) for calculating the future gain.
Concretely, if your property has appreciated since you acquired it, the difference between the FMV at the change of use and your original cost is a capital gain. This gain must, in principle, be reported for the year of the change of use.
There is an important nuance depending on the direction of the change:
- Principal residence becoming a rental: the gain accrued while the property was your principal residence is generally covered by the principal residence exemption. It is the gain accruing after the change of use that becomes taxable.
- Rental becoming a principal residence: the gain accrued during the rental period is taxable at the applicable inclusion rate, unless deferred by a tax election.
Tax with no money in hand
The trap of a change of use: the deemed disposition can generate tax payable even though no amount has been received. You have not sold, but the tax authorities calculate the gain as if you had. This is precisely why the 45(2) and 45(3) elections exist.
Source: Canada Revenue Agency — Changing your property to a rental or business property (and vice versa).
How does the subsection 45(2) election defer the tax (residence → rental)?
The 45(2) election (section 284 of the Québec Taxation Act) applies when a principal residence becomes a rental property. It lets you avoid reporting the deemed disposition, defer the gain until the actual sale, and designate the property as your principal residence for up to 4 additional years — if no CCA has been claimed.
When you turn your principal residence into an income property, subsection 45(2) of the Income Tax Act lets you elect not to be considered to have changed the use of the property. The result: you defer recognition of the deemed disposition — and therefore the tax — until the actual sale of the property.
This election offers an added benefit: it lets you continue to designate the property as your principal residence for up to four additional years after the rental begins, even if you no longer live there. This extended designation can reduce, or even eliminate, the taxable gain — provided you do not designate another property as your principal residence for those same years.
The core condition: you must not have claimed capital cost allowance (CCA/DPA) on the property. As soon as CCA is claimed on the rental portion for any year after 1984, the 45(2) election becomes impossible.
How to file the 45(2) election
- Attach a signed letter to your income tax return for the year of the change of use
- Describe the property and the date of the change of use
- State that you are making an election under subsection 45(2) of the Income Tax Act (federal)
- In Québec, invoke section 284 of the Taxation Act with Revenu Québec
- Claim no CCA on the property to preserve the election
Sources: CRA — Changing your property; Revenu Québec — Change of Use (s. 284).
How does the subsection 45(3) election work (rental → residence)?
The 45(3) election (section 286.1 of the Québec Taxation Act) applies when a rental property becomes your principal residence. It defers the gain from the deemed disposition until the actual sale and lets you designate the property as your principal residence for up to 4 years prior to the change — if no CCA has been claimed after 1984.
The reverse situation is just as common: you own a rental property or a unit in your plex that you decide to occupy yourself. This move from a rental use to a personal use is also a change of use, and therefore a deemed disposition at FMV.
Subsection 45(3) of the Income Tax Act then lets you defer the capital gain arising from that deemed disposition until the actual sale of the property. Better still: it allows you to designate the property as your principal residence for up to four years prior to the change of use, which can reduce the taxable gain for the rental period.
The same restriction applies: the 45(3) election is impossible if CCA has been claimed on the property for any year after 1984. In Québec, this election is made under section 286.1 of the Taxation Act.
| Element | 45(2) election | 45(3) election |
|---|---|---|
| Direction of change | Principal residence → rental | Rental → principal residence |
| Effect | Defers the deemed disposition | Defers the gain until the sale |
| Principal residence designation | Up to 4 years after the change | Up to 4 years before the change |
| CCA condition | No CCA claimed | No CCA claimed (after 1984) |
| Québec reference | S. 284, Taxation Act | S. 286.1, Taxation Act |
Sources: CRA — Changing your property; Revenu Québec — Change of Use.
How does a change of use apply to a plex owner-occupant?
In a plex where you live in one unit and rent the others, the property has a mixed use from the start. A partial change of use occurs when you change the proportion you occupy versus the proportion you rent. The deemed disposition then applies to the portion whose use changes, calculated by square footage.
The plex owner-occupant — the one who lives in one unit of their duplex, triplex, or quadruplex and rents the others — faces a particular tax reality. Their building has a mixed use: one part serves as a principal residence, the other is used to earn income.
A partial change of use occurs when that proportion changes. Typical examples on the North Shore:
- You move out of your triplex unit to live elsewhere and now rent out your former unit — the residential portion becomes rental;
- You take back a unit you were renting to occupy it yourself — the rental portion becomes residential;
- You convert an occupied basement into an additional rental unit.
In each of these cases, the deemed disposition applies to the portion whose use changes, generally calculated by the relative square footage of the units. The CRA also provides a de minimis rule: when the change of use is ancillary, small in scale, and no CCA is claimed, it may not be necessary to recognize a deemed disposition. This rule is delicate to apply, however — a tax specialist should validate your situation.
"You are considered to have sold your property (or the part of it whose use you change) at its fair market value and to have immediately reacquired it for the same amount."
— Adaptation of the change of use rules, Revenu Québec and the Canada Revenue AgencyHow does a change of use affect the future sale of your plex?
The fair market value used at the change of use becomes the property's new tax cost. On the later sale of your plex, the taxable gain is calculated from this value. Documenting the FMV well at the moment of the change (appraisal, comparables, square footage per use) is therefore essential for a North Shore owner.
A change of use is not just a one-time event: it redefines the tax starting point of your property for all subsequent years. The FMV established at the moment of the change becomes the reference cost for calculating the gain on the actual sale of your plex.
For an owner of a North Shore income property — Terrebonne, Mascouche, Blainville, Boisbriand, Saint-Jérôme, Saint-Eustache, Deux-Montagnes — where values have risen sharply in recent years, the gap between the FMV at the change of use and the future sale price directly determines the tax payable. Hence the importance of documenting this value rigorously: certified appraisal, market comparables, square footage of each use, photos, and the condition of the property.
To dig deeper into the mechanics of the tax on sale, see our guide on capital gains on the sale of your plex and, if you claimed CCA, our article on CCA recapture on sale.
Planning a change of use for your plex, then a sale?
Before turning a residence into a rental (or the reverse), then selling, have the full tax impact analyzed. ImmoMulti buys income properties across the North Shore, with no broker and no commission. Get a confidential offer within 48 hours.
Finally, remember that these tax elections are irreversible in several cases and subject to strict filing deadlines. Before you act, consult a tax specialist, accountant, or notary to analyze your specific situation and file the required documents correctly.
Informational content only. Does not constitute legal or tax advice. Tax rules and thresholds may change. Consult a tax specialist, accountant, or notary for advice specific to your property and situation.
