The topic of a rental suite in your house possibly triggering capital gains tax when sold has been covered extensively on this site (here and here and here). In short, normally you don’t pay capital gains tax when selling a principal residence, but a self-contained suite of significant size may mean that capital gains is due on the suite portion of the home. So far the writing from CRA and several articles indicate this is the case, but we’ve also heard that several local accountants have dismissed the concerns especially when the suite is small in relation to the whole house. It certainly seems that the more self-contained the suite is and the larger it is relative to the property, the greater the chance it could trigger capital gains. As always, ask a professional about your personal situation.
Even if capital gains tax applies due to your suite, what would be the impact? Would the capital gains tax completely destroy the profit from the suite, making it better to buy a house without a suite? To follow up on this, reader CuriousCat (who dug up the original information on this change) went through the calculations and produced a spreadsheet comparing two scenarios. Here is CuriousCat’s analysis (edits for presentation in this blog):
What if you compare two buyers, both purchased a house for $800,000 and sold for $1,200,000, 5 years later? They both put 20% down, the only difference being that one buyer did not rent out a suite, while the other rented it for $1400/mth.
The point of the tax system, as we keep being reminded by the feds, is that they want it to be fair (an incorporated doctor should pay the same amount of taxes as a non-incorporated doctor, etc.) So is it? Who comes out ahead? The buyer without the suite, or the one with the suite who is forced to pay all his taxes on the rental income and capital gains?
First we have the purchase of the two properties
Then we need to operate them for 5 years and calculate the total cash we have to put into them consisting of the mortgage payment and down payment, minus rent collected.
Then we sell both properties for $1.2M.
After 5 years, the landlord is ahead by $84,000. But we haven’t paid any taxes yet. If capital gains applies:
Then the landlord’s profit drops to $44,000. And if the landlord reported his rental income every year (and writes off the relevant expenses):
In conclusion, even when paying capital gains and all income taxes, with very strong appreciation in a property, the landlord remains ahead by $36,640 for the 5 year period. Of course we know most people don’t pay all their taxes (especially the capital gains), so then they come out ahead quite a lot. You can access the spreadsheet here and change the numbers for your own analysis.
My Take: Thanks to CuriousCat for preparing this. While the impact of the capital gains is large if it applies, it would appear that it still makes financial sense to rent out a suite rather than leave it empty. In times of slower price appreciation than the example, the impact would also be significantly less.
The other way to look at it of course is that the capital gains + income tax on the rental in the example combined to create a 56% tax rate. That might be hard to swallow regardless of final outcome.