Converting a home to a rental, or a rental to a home, is a deemed disposition at fair market value under section 45(1), with an immediate deemed reacquisition at the same value. A section 45(2) election defers it on the way in and lets you keep designating the property as your principal residence while not living there — for up to four tax years, a limit found in paragraph (d) of the definition in section 54, not in section 45. Section 54.1 removes the cap only where an arm’s length employer relocation applies, the property is at least 40 kilometres farther from the new workplace than the new home, and you move back in. A section 45(3) election works in reverse — but section 45(4) deems it never made if any capital cost allowance was claimed. Sales must be reported; a late designation carries $100 a month to a maximum of $8,000.
Moving out of your home and renting it out is a deemed sale for tax purposes, even though no money changes hands and nobody transfers title. Two elections exist to manage that, and one of them can be destroyed by a single line on your tax return.
The deemed disposition
Section 45(1)(a) of the Income Tax Act: where a taxpayer who acquired property for some other purpose “has commenced at a later time to use it for the purpose of gaining or producing income”, they are deemed to have disposed of it at fair market value at that time and immediately reacquired it at that same value. The reverse applies going the other way.
Paragraph 45(1)(c) does the same thing proportionally for a partial change — renting out a basement, say — where the relative use changes.
The principal residence exemption usually protects the gain up to that point. The problem is what happens after: from the deemed reacquisition onward the property is income-producing, and gains from then on are taxable. That is why the elections matter.
The 45(2) election: home becomes rental
Made in your return of income for the year, a section 45(2) election deems you “not to have begun to use the property for the purpose of gaining or producing income”. The deemed disposition is deferred, and — the real benefit — the property can still be designated as your principal residence even though you are not living in it.
Under paragraph 45(2)(c) you can rescind the election in a later year, in which case you are deemed to have begun the income use on the first day of that subsequent year.
The four-year limit is not in section 45
People look for it there and do not find it. It is in paragraph (d) of the definition of “principal residence” in section 54. CRA’s folio puts it plainly at paragraph 2.50: a property can qualify as a principal residence for up to four tax years while a 45(2) election is in force, even if the housing unit is not ordinarily inhabited.
The extension, and its conditions
Section 54.1 removes the four-year cap where you are away because of an employer relocation. The conditions are strict and all of them bite:
- The relocation must be of your or your spouse’s place of employment;
- The employer must be one to whom you are not related — an arm’s length employer;
- The property must be at least 40 kilometres farther from the new place of employment than your new residence is; and
- You must move back in during the employment or before the end of the year following the year that employment terminates — or die in service.
There is no open-ended extension. If you never move back in, section 54.1 does not apply.
The 45(3) election: rental becomes home — and the CCA trap
Section 45(3) works the other way: where income-producing property becomes your principal residence, the deemed disposition is avoided if you elect in writing.
Then read section 45(4). A section 45(3) election is “deemed not to have been made” if capital cost allowance was allowed on the property. One CCA claim, in any year, and the election you are relying on simply never existed.
This is the most expensive small decision in residential rental tax. Claiming CCA saves modest tax now and can cost the entire benefit of a 45(3) election later — on top of the recapture that claiming CCA already creates on a sale. It is worth a conversation with your accountant before the first return, not after the fifth.
Reporting the sale — and the penalty for forgetting
Since 2016 a sale of a principal residence must be reported, on Schedule 3 and, where a designation is required, on form T2091. This catches people who assume that because the gain is exempt there is nothing to report.
A late designation can be accepted, but sections 220(3.21)(a.1) and 220(3.5) provide for a penalty of $100 per month, to a maximum of $8,000. That figure is in the statute rather than on CRA’s consumer page, which is why it surprises people.
The practical sequence
- Get a valuation at the change of use. Whether or not you elect, the fair market value on that date is the number everything later depends on. Reconstructing it years afterwards is painful.
- Decide on the election before you file, not afterwards.
- If you elect under 45(2), diary the four years — and check whether section 54.1 genuinely applies before assuming an extension.
- Do not claim CCA without understanding what it does to a future 45(3) election and to recapture.
- Report the sale. Exempt is not the same as unreportable.
Thinking about keeping your current home and renting it out?
This decision has a tax consequence on the day you move out, whether or not anyone tells you about it, and the single most useful thing you can do is establish the fair market value at that date while it is easy to establish. I can give you a properly documented opinion of value for that purpose, and tell you what questions to put to your accountant about the election. The election itself, and anything to do with CCA, has to be their call rather than mine.
connect@jatindua.com · 437-987-1925 · Book a free consultation
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Frequently asked questions
Is it a taxable event to turn my home into a rental?
It is a deemed disposition. Paragraph 45(1)(a) of the Income Tax Act provides that where a taxpayer who acquired property for some other purpose later begins to use it for the purpose of gaining or producing income, they are deemed to have disposed of it at fair market value at that time and to have immediately reacquired it at that value. The principal residence exemption will usually shelter the gain to that point, but from the deemed reacquisition onward the property is income-producing and later gains are taxable. Paragraph 45(1)(c) applies the same treatment proportionally where only part of the use changes, such as renting out a basement.
What does a section 45(2) election do?
It defers the deemed disposition when a principal residence is converted in whole or in part to income-producing use. Paragraph 45(2)(a) deems the taxpayer not to have begun to use the property for the purpose of gaining or producing income. The practical benefit is that the property can still be designated as a principal residence while the election is in force even though the owner is not living in it. The election is made in the return of income for the year, and under paragraph 45(2)(c) it can be rescinded in a later year, in which case income use is deemed to begin on the first day of that subsequent year.
How long does the four-year rule last, and where is it?
Four tax years, and it is in paragraph (d) of the definition of principal residence in section 54 of the Income Tax Act, not in section 45 where most people look for it. The Canada Revenue Agency’s principal residence folio confirms at paragraph 2.50 that a property can qualify as a principal residence for up to four tax years during which a subsection 45(2) election remains in force, even if the housing unit is not ordinarily inhabited.
Can the four-year limit be extended?
Only under section 54.1, and the conditions are strict. The taxpayer must not ordinarily inhabit the property as a consequence of a relocation of their own or their spouse’s place of employment, with an employer to whom they are not related. The property must at all times be at least forty kilometres farther from the new place of employment than the subsequent residence. And the taxpayer must subsequently move back in during the term of that employment or before the end of the taxation year immediately following the year that employment terminates, or must die during the employment. There is no open-ended extension.
What is the section 45(3) election and how can it be lost?
Subsection 45(3) allows a taxpayer to avoid the deemed disposition where property acquired for the purpose of gaining or producing income ceases to be used for that purpose and becomes their principal residence, by electing in writing. Subsection 45(4) then provides that the election is deemed not to have been made if capital cost allowance was allowed in respect of the property. A single capital cost allowance claim in any year therefore removes the benefit of the election entirely, on top of the recapture that claiming capital cost allowance already creates on a later disposition.
Do I have to report the sale of my principal residence?
Yes, even though the gain may be fully exempt. The sale is reported on Schedule 3 and, where a designation is required, on form T2091. A late designation may be accepted, but paragraph 220(3.21)(a.1) and subsection 220(3.5) of the Income Tax Act provide for a penalty of $100 per month to a maximum of $8,000. That figure comes from the statute and does not appear on the Agency’s consumer-facing page, which is why it catches people out.
Related reading
- The foreign buyer ban: what it actually catches
- The Underused Housing Tax is gone — but not for 2022 to 2024
- Bare trusts and T3 reporting: where it stands now
- Renting out property as a non-resident: the 25% trap
Sources
Every figure on this page traces to one of these, and each was read on 1 September 2026. Primary sources only — statute, regulation, and the government or agency that administers the rule. Where I could not verify something from a primary source, the page says so instead of guessing.
- Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.). Justice Laws Website, read 2 September 2026. Section 45(1) sets out the deemed disposition on a change of use; section 45(2) and 45(3) provide the elections; section 45(4) deems a section 45(3) election not to have been made where capital cost allowance was claimed. The four-year limit is in paragraph (d) of the definition of principal residence in section 54, and section 54.1 removes it where an arm’s length employer relocation applies and the taxpayer moves back in, subject to a forty kilometre test. Section 212(1)(d) imposes the twenty-five per cent withholding on rent paid to a non-resident, section 215(6) makes a person who fails to withhold liable for the whole amount, and section 216 provides the election to file a Canadian return on net rental income. Accessed 1 September 2026.
- Income Tax Folio S1-F3-C2, Principal Residence — Canada Revenue Agency. Canada Revenue Agency, date modified 30 January 2024. Paragraph 2.48 confirms the deemed disposition on complete conversion to income-producing use and paragraph 2.57 the partial deemed disposition on partial conversion. Paragraph 2.50 states that a property can qualify as a principal residence for up to four tax years while a subsection 45(2) election is in force even if not ordinarily inhabited, and paragraph 2.52 confirms the forty kilometre test in section 54.1. Accessed 1 September 2026.
About the author — Jatin Dua, Broker of Record
I’m the Broker of Record at RE/MAX Quantum Realty, 799 The Queensway in Etobicoke. I am not an accountant, a tax lawyer or an immigration lawyer, and nothing on this page is advice about your own position. Anything that turns on your residency, your corporate structure or your filing history goes to a professional who can see the whole picture.
What I can do is read the statute and the Canada Revenue Agency’s own material and quote them accurately, with the section number and the date the source carries. Tax rules in this area change fast and a great deal of what circulates online is describing law that has since been amended, deferred or repealed. Where that is the case, the page says so. connect@jatindua.com or 437-987-1925.