Does a suite risk capital gains tax? A professional perspective
Normally when you sell a principal residence and the property has gone up in value, you don’t have to pay any capital gains tax, due to the principal residence exemption (PRE). However these days many people, by choice or necessity, don’t live in their entire house but rent out a suite. A rental suite is an income-producing use, and thus, similar to use of part of a home for business purposes, would normally mean the principal residence exemption does not apply to that portion of the home and capital gains tax is due. However, the CRA states:
It is the CRA’s practice to consider that the entire property retains its nature as a principal residence, where all of the following conditions are met:
- the income-producing use is ancillary to the main use of the property as a residence;
- there is no structural change to the property; and
- no CCA is claimed on the property.
It’s clear that claiming Capital Cost Allowance on a rental suite is a bad idea for this reason and is thus almost never done. But what of the other two requirements? What exactly does ancillary mean and what modifications to your house are considered structural? We have discussed these issues on this blog many times but I’ve never been able to reconcile the language which seems to clearly indicate that most suites would jeopardise the PRE with the reality that no one seems to be paying capital gains on the sale of homes with suites.
To get to the bottom of this, I had a conversation with Ammo Baines, Partner at Hutcheson & Co. Ammo is a CPA and CA, with 18 years of experience and has been practising in Victoria since 2006. What follows is our conversation on this topic. 
What are your thoughts on the word “ancillary”, is there a definition of that you use when advising clients?
I’ll have a discussion with clients who have a rental or business in their home that’s over 25% of the floor area, explaining to people that it’s possible that the CRA could assess this way. I’ve never seen it assessed personally in practice but just to be aware it’s an area where the CRA could cause some issues.
When we get to 40% or above, I get a little more serious about that warning to clients and especially if you’re over 50%. For example if you’re buying a house and living in the suite and renting the house, I would probably file divided use capital gains or strongly advise that’s how that should be reported.
What about the structural modifications clause? This tax interpretation mentions that adding a kitchen, adding an exterior door, adding or moving walls would be considered to be structural modifications. Doesn’t that describe every suite?
I don’t know how much weight I would put on that, as you say it would describe every suite, but you could have a 600 sqft suite in a 3000 sqft home and I don’t think that would be taxable. I haven’t seen capital gains assessed in 18 years of practice, and the tax interpretation isn’t going to be binding, you’re going to have to look at the act itself and make the argument around that. I think they’re setting themselves up to potentially make their argument, but in our role we are looking to defeat their argument where we can and it’s highly case specific.
If someone was concerned about the structural modifications clause, they may think it’s safer to buy a house with a suite already built and be in the clear. What do you think of that approach and is that any less risky than converting a house to have a suite yourself?
No payoff in my opinion. Ultimately you have a suite you have a suite. You have to think about the inconsistency in assessments, if they start assessing these frequently and assess those situations differently that doesn’t pass the smell test.
Victoria and Saanich now allow fully detached garden suites in backyards. Do you think a fully detached garden suite has a different risk profile than a basement suite?
In my opinion, if you don’t have access from the house you’re going to be first in line to get caught. There first has to be a policy shift to target suites, but if it happened the person with a garden suite would be at higher risk than someone with an in-house suite. You can just think about the arguments, like in the Boulet case with a separate address, you have to question what’s the purpose of that if not solely for rental income.
It seems clear from the language on structural modifications that are typically done to put in suites that the CRA could go after many suites for capital gains. Why do you think they aren’t, is it political?
I think it’s very political in nature and the sympathy on the other side is too strong. The reason you have suites in the first place is that properties are so difficult to afford, especially in our market. In addition we have a shortage of rental housing here and if you take housing away, that’s the opposite of what the federal, provincial, and municipal are trying to do here.
As of 2016, people have had to report the sale of their principal residences to the CRA. Do you think that increases the risk at all of losing part of the principal residence exemption due to a suite?
Yeah fair enough. If you have a database you can pull a query and if there’s a reported sale of a principal residence and rental income, then there’s some fields to look at. If there was a program where they were targeting this then there is data there to do it. But again they have to shift on a policy front first and decide to target suites.
I assume at some point the government may be under pressure to raise some revenue given the unprecedented spending after COVID.
We’re having lots of discussions about that right now in the office. They’re going to have to, we’re so far away from normal with the spending rate right now.
How do you talk to clients about the risk of having to pay capital gains tax?
I would have a discussion with clients to ensure they understand the risk by talking about some of these attributes specific to their situation. I wouldn’t usually file and report a gain, but let them know that it could come back to them in an assessment.
However it’s important to remember that you’re not going to pay tax unless you make money, so unless something good happens to you there’s no tax.
Let’s consider a typical suite of say, a bit less than 40% of the house. Would you classify the risk of having to pay capital gains tax as high, medium, or low?
I wouldn’t call it high risk, and wouldn’t call it medium risk because I’ve never seen it. Even given the factors we’ve discussed today that we’re in a tax deficit and would need to collect more revenue in the future, I would give it a low risk. Even very low for a small suite like 15% of the square footage.
Would you have assessed the risk as the same 10 years ago?
No, 10 years ago it wasn’t even on the radar so I would say that the risk is higher now. A couple elections ago I started to hear public statements I hadn’t heard before, along with the higher values of homes and associated higher capital gains. And now we have the COVID deficit, so we’re even a bit more on the radar than we were a year ago. However in a market like Victoria a policy to pursue this would hit so much of the voter population it would be very unpopular.
There you have it. It’s nice to see a lot of the conclusions we’ve come to on this topic confirmed by a professional. On paper a suite jeopardises the PRE, but for anyone buying a house with a suite it’s reassuring that this has not been a priority for the CRA to date and it would be politically difficult to change that. That said I think it’s wise to keep in mind that the risk may have increased in recent years, and to take into account the possibility of having to pay tax on the portion of the house that is income producing. I really appreciate Ammo’s reminder that in some ways a tax problem is a good problem to have because it means you made money. A reader previously provided a worked example of a situation that showed the impact of the capital gains tax, and that even if it was due a rental suite would still yield a (lesser) profit.
As always, this is not tax advice and your situation may be different. Please consult your accountant or reach out to our friends at Hutcheson & Co.
Insofar as I understood it, accounting practice I was told, appliances must be claimed via the CCA form and depreciated over several years (20% per year). If we claimed the suite’s appliances via CCA, a SMALL percentage of the suite for sure, are we now subject to capital gains on the whole suite? If so, is there any way of going back to fix this error and paying back some amount? (Yes, a real accountant did our taxes). Also, I understand the CCA is ONLY on the building portion, not the land. We use our suite sometimes for renters and sometimes for family visits.
I’m well aware of low rates making the debt manageable, but I’m definitely not on board with the deficits don’t matter crowd. They absolutely do.
True. But I’m not talking about “the wealthy” per se here. I’m talking about perfectly ordinary people making solid incomes that both kept their jobs and saw no impact from COVID other than working at home for some time. We all should probably expect higher taxes in the future to pay for the say $500B that will be spent to get through the crisis.
You are right. When I clicked on , it went to the comments right away. I didn’t realize the comments were from the new post of Leo’s. So I just read at the time the top few comments when I responded. I’m used to Leo doing a new post each Monday and not on a Thursday. Sorry bout that.
In my case, I rent the entire house to a tenant, my property manager collects the rent and it is directly deposited in the bank therefore 100% of the rent is declared. Fortunately, mortgage interest, repairs, taxes , insurance and management fees leave little taxable earnings. I have no idea if my tenant is renting out rooms to other people, or growing marijuana. So far so good. I never expected an income from my properties, only capital gains and paying down the principle as interest rates are so low. Still a better investment than the stock market if you have an eye for quality properties in good neighbourhoods with no structural issues.
“It’s not their money, it’s our money. An awful lot of money if you give every renter a 100% deduction. Plus it would benefit higher income renters disproportionately. Want to spend tax money, increase rental supply.”
What are you even saying here?!
Our money? Our money isn’t even making its way into the tax coffers cause 80% of Victorians don’t claim suite rent. I would rather get the taxes on that suite rent then worry about a “higher income earner” which probably aren’t the ones struggling to pay rent anyways.
When you allow amateur landlords into the market, just like amateur hoteliers (read Airbnb) you will always have a huge loss in taxable revenue.
So the answer is definitely not ‘increase rent supply’
Whenever I bring up the tax evasion suite rent issue these boards go silent except for the few honest sophisticated landlords that pay tax on it.
On another note if they are going to tax home equity can we deduct mortgage interest, upkeep and insurance? Also if we sell our home at a loss can we claim a Capital Loss.
This is going to get interesting.
We’re talking about federal government workers here. There’s no collection incentive structure in place. Perceiving greed on behalf of the CRA is silly.
Did you even read the article you are commenting on? The article goes into this in detail.
I agree with finding ways to reducing your taxes like finding additional write-offs. However, I don’t believe in avoiding taxes altogether. Arguments that the rich do it even more or it is not high on the CRA’s priority list ring hollow to me. I am sure the large tax avoiders use the same arguments.
We live in a society that is built on trust including trust that people will pay their taxes. If everyone avoids paying taxes the system breaks down, because the government agencies don’t have the resources to go after everyone.
That’s what happened when capital gains taxation was introduced in 1971. Before that there was no principal residence exemption because there was nothing to exempt.
I would be a little less confident when it comes to tweaking administrative guidelines though.
It’s not their money, it’s our money. An awful lot of money if you give every renter a 100% deduction. Plus it would benefit higher income renters disproportionately. Want to spend tax money, increase rental supply.
I was just trying to keep it simple. I have been in this situation several times with no problem. I have ALWAYS declared the income for a rental suite………so Revenue Canada is not thinking at anytime that I am pulling the wool over their eyes. Sure things could change but one would probably be grandfathered in if it did. Or you may have to have your property assessed at the time of the tax policy change, and the capital gain maybe applied from that time forward if you were to sell. Who knows.
FYI google: “Beware the big tax hit that could be lurking in your basement…………”
“The CRA has a long standing admin policy…….If you meet 3 conditions…
You don’t make any structural changes………so basically the suite was there when you bought it. So you didn’t add a kitchen of bathroom for instance.
You don’t deduct tax depreciation on the portion of your residence that is the suite.
As I said, always ask and go to a chartered/general accountant & phone CRA for confirmation.
The wealthy should pay more, but they have PRECs and Holdcos and lots of tax loopholes to exploit. And they still have the gall to complain about taxes.
Second, people going into politics tend to be wealthier than average, which incents them not to tax wealth and income aggressively.
CCA is only one of 3 requirements. All must be fullfilled to retain the principal residence exemption to capital gains tax. And every self-contained suite was created via structural modifications. The point is on paper, the CRA could pursue you for most suites, but they just haven’t done so in the past. Will they ever? No one knows, Ammo thought the chance was still low but it’s going to be case-specific. If they ever start looking at this then they’re going to start with the obvious cases first.
I thought it was interesting that in the case where someone buys a house and lives in the suite (so 50% or greater is rented out) then he would strongly advise to file divided use. How many people are doing that rather than trying to claim the entire principal residence exemption? I bet not many
If you have a “basement suite” in your house, and the size is say 30% of the total square feet of the house, and your worried about capital gains….then don’t claim the CCA. You declare the income from the suite, you are able to write off say 1/3rd of the taxes, insurance, utilities & maintenance etc. You can’t write off a new stove etc. in the suite but you can write off the entire amount to maintain the stove, i.e. 100%. Same with the new roof….no write off….but maintaining the roof (patch) ? Yes.
This way, you don’t pay capital gains on the sale of your home. Best to go to an accountant (100% write off), to do your income tax at least for the first couple of years so you understand what you are doing.
The concept that those wealthier people will not have to pay for the spending is pure fantasy. For anyone that kept their job and is as good or better off now than before expect to pay for it at some point in the future. That’s how it should be, we live in a society and there should be no complaining about some taxes when many other people have had their lives completely unravel from this.
Yes and no. Homeowners are the making the same amount of money on appreciation regardless of whether there’s a suite. It’s the land value going up that drives this profit, not the existence of the suite. I’ve pointed out before that during times of rapid appreciation (2015–2017) a homeowner renting a suite might be financially better off if they left their suite vacant during this time, in a world where CRA decides to enforce. That’s the piece of this possible tax that doesn’t jive for me – there’s no connection between the potential tax liability and the benefit gained by renting a suite.
You can claim a deduction for expenses based on the percent of floor space used for the suite which is then on record with CRA. Difficult to assert that you have a suite of only 30% floor space if you claimed a 40% deduction.
I’m not a mortgage broker so perhaps this is incorrect but it is what is stated on mortgage broker sites in Canada regarding unauthorized suite income use for qualification purposes:
https://peaktopeakmortgage.com/basement-suites/
CMHC has an explicit policy on this that states that only legal suite income can be used and if legal 100% can be used (used to be 50%):
The property must be owner-occupied.
The property being insured can have only two units (i.e., a duplex or a single home with a legal secondary suite).
Rental income cannot be used if the suite is “illegal/non-conforming” but “legal non-conforming” is okay. (Non-conforming means that the suite was grandfathered in before zoning/regulations restricted such units. You can check with the city to confirm if a suite is legal.)
The suite must be self-contained with its own entrance.
For existing units, there must be two-year history of rental income from the suite. The maximum rental income allowed for qualification is a two-year average of the unit’s rent.
For new units, a market rent appraisal can be accepted if an appropriate vacancy rate has been applied to the estimated rental income.
Hahahaha.
Uh oh. A dose of common sense.
No one is going after either. The point is risk of both of them being subject to tax at some point has increased now, so good thing to be aware of.
For all the same reasons discussed in this interview, unlimited tax free capital gains in the principal residence could also be less certain going forward. That would be a more popular move, just limit the tax free capital gains to like 3%-4% of the houses value per year. So a reasonable increase is tax free but outsized gains are taxed
Exactly and a variety of purpose built rental, including ground oriented units suitable for families.
As for strata conversions, many places including Saanich have strata conversion policies prohibiting them if the rental vacancy rate is below a certain level (4% for Saanich which we haven’t had for 40 years)
Off topic, but I am a little bit shocked by how many Oak Bay homes (not Uplands or waterfront) have been selling for over two million. Most of them seem to be new builts but all the same it seems like a crazy price tag
I wasn’t renting my suite in the end primarily due to taxes and the income bracket I was in. If capital gains were a thing I wouldn’t have bothered to ever rent it in the first place and would just have kept it as reserve potential income for a rainy day.
I know a number of people that are mortgage free renting their suite as they have no use for the space. If you throw enough negative policy/tax implications I have a feeling a decent absolute number (small percentage) of people would pull their suites off the market.
This is why rental buildings are key imo….they pretty much remain rental inventory forever (extremely rare a rental building is converted to strata and sold).
Have to love this blog….tax professional says he hasn’t seen it in 18 years of practice and discussion goes into fear of what if again.
Not to mention it would appear that no one here lives in real life. Here is the reality of real life. Vast majority of suites are unauthorized and not on file with the municipality which means no one has a clue as to how big they are. If capital gains did one day become an issue, which there is no indication at this point, people could just moves a few interior doors/walls effectively cutting down a 30% floorspace suite to 20%, for example. Given that the suite was unauthorized in the first place without drawings the CRA has zero reference point. Now I’ll expect comments of CRA will call your previous 20 tenants to get an idea of how big suite was…bla bla bla.
Amongst a million other things. It is a tough one to enforce.
Big picture what bugs me more is the ultra wealthy flipping houses and pocketing millions tax free. There was house in Oak Bay that recently sold for $1.465 million more than 2014 purchase price. That individuals pockets that $1,465,000 tax free and we go after someone in Langford in an entry level home with a suite (providing accommodating in a housing crisis) for capital gains. Makes perfect sense.
I’ve never heard of this and I have been involved in 100s of SFH with suite transactions. The vast majority of property disclosure statements in Greater Victoria are checked off as “yes” when it comes to unauthorized accommodation so it is not like the lender/CHMC would not be aware and yet I have never heard of a discounted rate for unauthorized.
Maybe Mike Grace can chime in?
Yes, if the whole house was considered principal residence then it is not taxable. However in my case the suite portion of the house was not part of the principal residence so that portion was taxable as a capital gains.
In the end I was able to argue that the value of the house had stayed the same so I was not taxed at the time. However, I wanted to highlight there could be a chance of triggering a capital gains tax even if you do not sell the house.
“ It is probably a provincial level credit, as it has been done in Ontario: tax credit for rent paid by ON residents for their ON rentals, with details of rental address and landlord info) …”
I am not proposing a little tax credit (similar in Manitoba – you basically get the homeowner grant as a tenant)
What I am proposing: You make 40,000 gross in a year and pay 18,000 in rent your taxable income is now 22,000. Period. Easy peasy.
Governments can put their money where there mouth is if they really want help with affordability.
Not that they would, we will see a home equity tax before anything like this. Canada is in deep debt, next 6 months are gonna be scary.
At the start of my time as landlord I was running an operating loss which was deductible against my other income. Later due to rising rents and falling interest rates I was running a profit. Overall a profit I think but not much.
Moving out and renting out all of it is a change of use from principal residence to investment. The deemed sale of the principal residence is not taxable. If you move INTO a property you have been renting out that’s a deemed sale of an investment property which IS taxable.
If you need CMHC insurance it is different I believe. CMHC only permits the income from legal suites to be used to qualify. If the suite is not legal, Genworth and Canada Guaranty will still consider the rental income from the suite in your debt service calculations, depending on the strength of your overall application. Banks generally apply a discount rate to the unauthorized income where CMHC insurance is not required — usually 50%. Credit Unions may allow up to 90% of the income.
Thanks for the discussion Leo.
Agree with some of the previous comments. Claim the suite income. Not doing so is stupid and illegal.
Be aware that capital gains tax is a risk. Mitigate that risk by not renting out a huge portion of your house. Our suite is 25-35%. We can change the percentage because one room can be rented as part of the suite or used as part of the main living area. Currently our suite has been converted into guest quarters/play area.
I wonder if only renting out some of the time vs 100% of the time (and using the suite space for your family when it isn’t rented) could be a factor that would weigh in favour of determining that the rental was ancillary?
“People rent out suites because extra income is extra income and they had to qualify without the suite income unless the suite is legal” this is not true. banks don’t check the legality unless something if way offside – if its a suite with a separate entrance they will accept the income.
We were in the situation of renting out 40% of our house based on # of rooms, not sq footage. If we had used square footage it would have been more like 30%. We wanted maximum deductions of expenses including mortgage interest applied to the rental income.
We didn’t really think of the increased capital gains liability because of this, but it should be something homeowners should take into account.
Another thing to watch out for and the situation we found ourselves in, is that if you move out but keep the house it triggers change of use. This is treated by the CRA the same as a sale. We kept the house and rented out upstairs and downstairs. We had to file this as a sale and would have had to pay capital gains, even though we didn’t have any proceeds from a sale.
It is probably a provincial level credit, as it has been done in Ontario: tax credit for rent paid by ON residents for their ON rentals, with details of rental address and landlord info) …
People rent out suites because extra income is extra income and they had to qualify without the suite income unless the suite is legal, and for more recent owners at a much higher interest rate. Owners probably won’t remove a suite from the market because of capital gains, but disliking being a landlord plus capital gains will cause some people to reclaim the space imo.
We have. You end up paying less tax than you’d think due to deductions unless your mortgage has been discharged. The only bit that is difficult for some is that you pay income tax on equity paydown without actually having that money in hand to pay the tax with. I’d much rather be above-board on this than deal with an audit from a position of evasion.
The real elephant in the room.
“How many Victorians have ALWAYS claimed suite income annually?”
I would be shocked if it was over 20%
My proposition. Allow 100% of rent paid by tenant to be tax deductible. This way it keeps the landlords honest and taxes paid by landlords are credited to tenants.
In a past discussion, I seem to recall totoro did some back-of-the-envelope math and the CG hit for a typical person would be in the ballpark of $25K. And that figure could be further reduced by contributing strategically to your RRSP.
Now balance that ~$25K cost with a typical person’s ~$150K of rental income earned per decade.
And that’s assuming that CRA ever decides to pursue the PRE/suite situation.
Mind you, people should be declaring suite income to CRA. Not doing so is clear-cut tax evasion and an altogether different matter.
“and curiously don’t hear so much any more” – interesting -Maybe that should be your warning. Contrarian view. Just like the last correction. 2008 crash, interest rates drop, prices go up in the face of job losses and general economic pain and then a year later we see the ‘correction’ (only 10% but in today’s market that still counts for a cool 100k). At least that is what in hoping haha.
This OMINOUS warning is reminiscent of the ominous warnings of a price crash that we’ve heard for literally decades — and curiously don’t hear so much any more.
Well…. I sometimes disagree and sometimes agree with “Patriotz”.
I said what I said in my earlier post and stick by them.
Landlords will have to decide whether the extra income along with the extra hastle is worth it or not. It’s certainly one more straw on the camels back.
I believe that even the uncertainty of what will happen changes everything. If a landlord is on the fence about whether to increase the rent on a unit, I believe that many will take this into consideration and go with the increase.
Also: Patroitz”… with respect….. “increased rental demand pushes up rents”. It’s a whole set of factors that increase rents. Many of those factors are entangled and the government should think carefully before doing something that would be counterproductive to the health of our society…… that is already buckling and struggling to cope.
It’s not the CRA’s job to pass judgment on the wisdom of taxation policies – just to enforce them.
Increased rental demand pushes up rents. And capital gains taxation isn’t a current cost anyway. And note that that anyone renting out anything other than a suite is already subject to capital gains taxation.
People rent out suites because they need the money to pay the mortgage. They are not going to take them off the market just because of a capital gains hit somewhere down the road. And all businesses provide valuable services – that’s not a reason to give anyone a tax holiday. If the government is going to spend money (a tax holiday is essentially spending) it should go to non-profits, not homeowners planning on making a killing down the road.
Ammo’s assessment of the risk as low is disingenuous I think – it will go to “sky high” the second the first assessment rolls in, so I would say this: if you don’t want to get reassessed for multiple years at once for potentially hundreds of thousands of dollars in taxes on unreported capital gains, late fees and penalties, treat any suite income or suite capital gain the same as you would if it was a separate apartment for anything other than renting a room in your house.
I think this is one of the most widespread, contentious and inconsistently interpreted pieces of CRA legislation in Victoria, mostly because it affects like 60% of houses here and no CPA wants to be first to interpret the rules in a way that makes them lose clients first. I have had conversations with CPA’s from at many firms in the city on this exact same topic and the interpretation of the act is clear. It’s the application of the interpretation by the CRA that is not. Most CPA’s say the same thing as Ammo – “no enforcement in xx years”, not a big deal. Remember – a CPA firm takes no responsibility for the accuracy of your tax return for this year or any year and the fact that a rule hasn’t ever been enforced means nothing to the CRA. They have and are continuing to set themselves up with a new pocket to pick and when they decide to start enforcing things, watch out. They will go back as many years as they can, assess interest, late fees and anything else they can throw at you because they are allowed to.
Nice post, Leo. My favourite quote:
“I haven’t seen capital gains assessed in 18 years of practice”
Happy Friday, all.
I don’t doubt for a minute that the CRA will start to enforce this. They can’t see past the idea of getting more money. They rarely think about how they kill initiative and hard work.
It will push up rents because landlords rarely absorb increased costs. It will also take many suites out of the market because the CRA can’t see that landlords are providing a valuable service.
The result will be even more homeless people. More costs for policing, more first responder costs as people turn to drugs and crime because they can’t cope any more.
If you don’t believe me, just take a look at the mess in our cities already as people turn their backs on the system.
The CRA is incapable of seeing the connection. All they see is your wealth which should be theirs.
As for, “make the tenants pay cash”….. I don’t recommend that.
Always report income.
It’s just not a good idea and certainly not worth the headache.
For example:The CRA will catch you eventually. For example: They will see your address showing up in their system when your tenants file their income taxes.
It’s their game. Pay your taxes.
Anyone with a suite should already be factoring in this cost now on any suite and adding it to the costs of doing business….. because, like needing a new roof one day, it is only a matter of time before the CRA makes a move to grab this money.
Really great interview on a interesting topic.
How many people renting out part of their home request payment in cash, avoiding taxes altogether. I’m sure thousands. Tax evasion is a national pastime. It is especially prevalent in Europe from what I’m told.