Convert residence to rental property - Capital Gains tax payable?

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Sep 17th, 2010 12:42 pm

#101

bjserink: Member; Aug 16, 2004; 365 posts; 82 upvotes

Sep 17th, 2010 12:42 pm

wishfulthinking wrote: ↑So I've read through this thread, and the other one: Converting prime residence to rental, keeping existing mortgage - interest deductible?

It seems the Squid Maneuver is arguably viable thanks to section 15 of IT-533

However, I'm wondering if anyone has it in writing yet from the CRA saying that it's OK? Has anyone invested in an Advance income tax ruling from the CRA, specifically about the squid maneuver? FYI:

The cases mentioned in this thread are similar, but not similar enough to the Squid Maneuver to conclude it's legit. Anyone got anything concrete from the CRA?

Sorry, I never went through with the full squid maneuver. I just sold it to my fiancee (who wasn't on title), and didn't bother buying it back. I used the proceeds of the sale as downpayment on the new house, and she claims the income and deducts all the expenses for the rental. When we go to sell it, she will get hit with all of the capital gains tax (50% of the increase in value from when she bought it to when she sells it), and this is probably a good thing since we'll likely sell it when we decide to have a baby and she goes on mat leave - and thus reduced income.

Anyway, I did phone a tax lawyer to confirm that my methods were legit, and he advised me (for free) that he believes it would be - but said he would have to charge me $5000 to get that in writing. Getting a CRA ruling might be a bit cheaper, but still quite expensive. It might take a long time for your interest deductions to pay for that ruling! You might be better off with the "ignorance" approach: just go ahead and do it and if they investigate, say you were following the guidelines in IT-533. The worst they'll do is make you pay back the deductions.

I thought the Sherle case was pretty convincing. Well not the case itself but rather the judge's opinion on Sherle's "what I could have done" scenario. If the CRA came after you and you really wanted to fight with them, that judge's statements should give you some ammunition!

Sep 17th, 2010 12:50 pm

#102

bjserink: Member; Aug 16, 2004; 365 posts; 82 upvotes

Sep 17th, 2010 12:50 pm

villaseea wrote: ↑If you are comfortable with investing, I suggest you might as well get involved in a smith maneouvre. As your HELOC grows, just keep pumping funds into investments which fit your risk/return profile. I personally prefer this than the above-mentioned cash-damming strategy. If someone could chime in, I would like to know when and how(the quants) a cash-damming strategy would be preferrable.

Both the Smith maneuver and cash-dam strategy result in shifting your mortgage loan into a tax-deductible loan. The difference is risk. With investments, you never know when the market will crash and you are suddenly stuck with an extra loan and no equity to compensate. The cash-dam is just a way of moving money around when you have a small business or rental property. You are not borrowing money from your mortgage and risking it on anything... you are simply accelerating one loan while growing a tax-deductible loan by the same amount.

Mar 24th, 2011 5:41 pm

#103

stars78: Jr. Member; Nov 1, 2005; 192 posts; 27 upvotes

Mar 24th, 2011 5:41 pm

I know this is an old thread, but has anyone gone through with this in Toronto yet. My situation is that my spouse and I both own a paid off condo, and now we want to convert it to a rental as we've bought a new house. So how can we deduct the interest if we refinance it. Thinking of gifting it to my husband, then taking a line of credit to buy it back and deducting the line of credit interest. But I'm not sure if I'll have to pay land transfer tax (and if so, it would then be not worthwhile in my case). Recommendations of lawyers to do this in Toronto would also be appreciated.

Mar 24th, 2011 6:41 pm

#104

bjserink: Member; Aug 16, 2004; 365 posts; 82 upvotes

Mar 24th, 2011 6:41 pm

Sorry, as a resident of Alberta, I'm not familiar enough with land transfer taxes to answer your question. But you could probably just call up any real estate lawyer in the phone book and ask them if the tax would apply when selling from one spouse to the other.

+1

Jul 12th, 2011 8:14 am

#105

mwmah: Newbie; Dec 2, 2009; 16 posts; 5 upvotes

Jul 12th, 2011 8:14 am

Great thread guys, I got alot of information here. Here is an article from the Financial Post which makes things pretty clear and seems to validate the squid manuever.
http://www.financialpost.com/personal-f ... story.html

However, I do have a question based on the article if anybody can answer. Instead of selling it to parents for a promissary note and then buying it back, could it be sold to a spouse at fair market value instead (spouses name is not currently on the title) and have the spouse claim the rental income and deduct the interest.
That is a little vague to me as I have heard both sides of the story as it pertains to the CRA attribution rules (http://www.cabusinessadvisor.com/Tax/Ta ... Attrib.htm)

Jul 12th, 2011 3:17 pm

#106

bjserink: Member; Aug 16, 2004; 365 posts; 82 upvotes

Jul 12th, 2011 3:17 pm

mwmah wrote: ↑Instead of selling it to parents for a promissary note and then buying it back, could it be sold to a spouse at fair market value instead (spouses name is not currently on the title) and have the spouse claim the rental income and deduct the interest.

I'm no tax lawyer, but my research indicates that the attribution rules would not apply if you sell the property at fair market value to a spouse who pays for it with their own money. In this case, the purchasing spouse would have to qualify for the mortgage alone and use their own cash to pay the down-payment to the seller. Otherwise, you (the seller) are helping to buy the property from yourself, which not only could cause problems with the mortgage application and sale, but probably has some tax consequences too. For instance, attribution rules might apply if the seller helps to pay for it, unless you consider this as a loan and charge the buying person interest at a rate equal to the lesser of the prescribed rate for the quarter and the prevailing commercial rate.

Also, both spouses or partners must elect out of the rollover that automatically applies to spousal transfer of property. By doing so, the seller will be claiming any capital gains that have accumulated so far on the property. But if the seller was using the property as his/her principal residence, no capital gains would apply. The buyer now calculates an adjusted cost base using the purchase amount, and becomes responsible for claiming any capital gains/losses on the price difference in the year that he/she eventually sells the property. The buyer also becomes responsible for claiming all the income and deductions associated with the rental property - which is a good thing if the buying spouse is the lower income earner.

This is exactly what I did with the condo that I owned. My wife is now the owner and landlord, and we haven't had any trouble from the CRA. Of course, we haven't been audited yet and so I can't be sure we did everything correctly. One potential problem is that we had already combined our finances and some of the money she used as down-payment came out of our joint account (we transferred it into her old personal account first, but that isn't going to fool the CRA). But we could also argue that half of that joint money was hers, and could probably show statements to back up that claim.

Feb 28th, 2014 1:58 pm

#107

yehenrytian: Newbie; May 16, 2013; 12 posts; 1 upvote; Markham

Feb 28th, 2014 1:58 pm

Does anyone has a confirmed answer on the "refiancing mortgage" question yet? I own a townhouse for 4 years, and last year, I refiance its mortgage and use the money to buy my current new house. Then I rent my townhouse out last year. I want to know if the interest accumulated on that mortgage is tax deductible. From the Q and A on page 12 of CRA’s Rental Income guide explains CRA’s thinking:
Q. I own and rent a semi-detached house. This year, I refinanced the property to increase the mortgage because I needed money for a down payment on my personal residence. Can I deduct the additional interest on the mortgage against my rental income?

A. No. You are making personal use of the funds you got from refinancing your rental property. As a result, you cannot deduct the additional interest when you calculate your net income or loss from your rental property.

I think the point here is refinancing your "rental property" and "additional interest", which means the "original interest" on your original mortgage on the "rental property" is still tax deductible. So I think if the "refiancing" was done when the property is still my primary resident, then that should not apply to the rule on "refinancing your rental property", and this seems more fair no matter if you buy a "new" rental property, or turn your primary resident into a rental property. However I will need to confirm this with an accountant. But at least this is what my TD financial adviser was telling me, of course she could be wrong ... In Canada many things have to be figured out by ourselves ....

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Feb 28th, 2014 2:23 pm

#108

bjserink: Member; Aug 16, 2004; 365 posts; 82 upvotes

Feb 28th, 2014 2:23 pm

yehenrytian wrote: ↑Does anyone has a confirmed answer on the "refiancing mortgage" question yet?

Yes, the answer has been written on this thread extensively. Did you read it at all? Did you read the stuff about the Sherle case? About how the "Squid maneuver" and why it's necessary in order to be allowed to claim interest? The answers you seek are all here.

So I think if the "refiancing" was done when the property is still my primary resident, then that should not apply to the rule on "refinancing your rental property"

The situation described in the Q & A you posted is not the same as yours, but is similar. In your case, the answer would read as No. You are making personal use of the funds you got from refinancing your personal property. There is no "rule" about refinancing your rental property. The only relevant rule here is related to direct use of the borrowed funds, and has nothing to do with what was used as collateral for the funds. It makes no difference what property you refinanced. Even if you took out an unsecured line of credit to buy your new house, it doesn't change anything. It's only what you use the borrowed money for that matters. And you're directly using it to buy your new house. With the squid maneuver, the direct use of the loan is to buy back the rental property, and THAT is what makes the interest on the loan deductible. You didn't do this, so you cannot deduct the interest.

this seems more fair no matter if you buy a "new" rental property, or turn your primary resident into a rental property.

Yes, I agree it would be more fair. But who ever said Canada's tax laws are fair? There's no arguing how the law should be written around this issue, but the only thing that matters is how it is written. You can take your case to court, but like in the Sherle case, you will lose.

However I will need to confirm this with an accountant.

Not very many accountants are familiar with this particular area of tax law. They can probably look it up for you and come back to you with an answer, then charge you big bucks for their time. Or you can just research it yourself. Or just trust me (as a person who's studied this extensively and have been through it myself). It's up to you.

But at least this is what my TD financial adviser was telling me, of course she could be wrong

She's wrong. And not just about this... bank financial advisers are generally wrong about a lot of stuff. Often on purpose, because they really don't care what's best for you - that's just good acting. They only care what will earn themselves the highest commission, or earn their bank more money. I've even tested them at a TD branch before... playing dumb and asking questions about various financial issues even though I already know the answer that is best for me. And no surprise, they tried to push me toward investments or services that were not in my best interests, but made them more money. The fact that half of them don't even know about the eSeries funds and the other half intentionally lead you away from them is proof of this.

Feb 28th, 2014 2:55 pm

#109

Busybuyer888: Deal Fanatic; Apr 4, 2009; 7698 posts; 793 upvotes; North York

Feb 28th, 2014 2:55 pm

pluto wrote: ↑I've been crunching the numbers on this and I don't know with my current equity / value of the house(s), cost of borrowing, etc. if doing this will be profitable.

Suppose I was able to get someone to go 50/50 with me on the rental property down payment, and split the proceeds from the rental income. Would we each be able to deduct half of the expenses on the rental property (including the interest on the mortgage) from our personal income taxes?

Or would we have to set up a corporation....? This might be getting way too messy for me....

The only messy things is the ownership if either owner gets into financial trouble. (Partnership.)

Both would have to qualify for the mortgage. But if one person got into financial difficulties (ie. lost job) the other party would have to pay for entire mortgage. And that wouldn't affect the % ownership.

In worst case, one party could essentially have other party pay for entire mortgage and still own 1/2 the house.

And if one party need to sell the property, would you be okay, even if that ment losing money (ie. RE commission, original LTT, mortgage penalities.)

So there are these aspects that need to be though out (trust, stability) before jumping into a partnership arrangement.

Feb 28th, 2014 5:26 pm

#110

yehenrytian: Newbie; May 16, 2013; 12 posts; 1 upvote; Markham

Feb 28th, 2014 5:26 pm

bjserink wrote: ↑Yes, the answer has been written on this thread extensively. Did you read it at all? Did you read the stuff about the Sherle case? About how the "Squid maneuver" and why it's necessary in order to be allowed to claim interest? The answers you seek are all here.

The situation described in the Q & A you posted is not the same as yours, but is similar. In your case, the answer would read as No. You are making personal use of the funds you got from refinancing your personal property. There is no "rule" about refinancing your rental property. The only relevant rule here is related to direct use of the borrowed funds, and has nothing to do with what was used as collateral for the funds. It makes no difference what property you refinanced. Even if you took out an unsecured line of credit to buy your new house, it doesn't change anything. It's only what you use the borrowed money for that matters. And you're directly using it to buy your new house. With the squid maneuver, the direct use of the loan is to buy back the rental property, and THAT is what makes the interest on the loan deductible. You didn't do this, so you cannot deduct the interest.

Yes, I agree it would be more fair. But who ever said Canada's tax laws are fair? There's no arguing how the law should be written around this issue, but the only thing that matters is how it is written. You can take your case to court, but like in the Sherle case, you will lose.

Not very many accountants are familiar with this particular area of tax law. They can probably look it up for you and come back to you with an answer, then charge you big bucks for their time. Or you can just research it yourself. Or just trust me (as a person who's studied this extensively and have been through it myself). It's up to you.

She's wrong. And not just about this... bank financial advisers are generally wrong about a lot of stuff. Often on purpose, because they really don't care what's best for you - that's just good acting. They only care what will earn themselves the highest commission, or earn their bank more money. I've even tested them at a TD branch before... playing dumb and asking questions about various financial issues even though I already know the answer that is best for me. And no surprise, they tried to push me toward investments or services that were not in my best interests, but made them more money. The fact that half of them don't even know about the eSeries funds and the other half intentionally lead you away from them is proof of this.

Thanks for your detail reply. But I think cases like mine are different, I found the following paragraph here: http://www.cra-arc.gc.ca/E/pub/tp/it533 ... P249_43576

Refinancing transactions
¶ 41. Where borrowed money is used to repay existing borrowed money or an amount payable for property acquired, the new borrowed money is deemed to have been used for the purpose for which the money previously borrowed was used or to acquire the property upon which amounts were owing, as the case may be, by virtue of subsection 20(3).

In other word I had the original mortgage on my property that I was going to rent it out, So the "refinanced" mortgage should be viewed is used as the same purpose as my previous mortgage, which is to buy the property. So the interest on the refiance mortgage should be tax deductible.

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+1

Mar 1st, 2014 2:00 pm

#111

asif9t9: Member; Apr 18, 2006; 405 posts; 70 upvotes

Mar 1st, 2014 2:00 pm

yehenrytian wrote: ↑Thanks for your detail reply. But I think cases like mine are different, I found the following paragraph here: http://www.cra-arc.gc.ca/E/pub/tp/it533 ... P249_43576

Refinancing transactions
¶ 41. Where borrowed money is used to repay existing borrowed money or an amount payable for property acquired, the new borrowed money is deemed to have been used for the purpose for which the money previously borrowed was used or to acquire the property upon which amounts were owing, as the case may be, by virtue of subsection 20(3).

In other word I had the original mortgage on my property that I was going to rent it out, So the "refinanced" mortgage should be viewed is used as the same purpose as my previous mortgage, which is to buy the property. So the interest on the refiance mortgage should be tax deductible.

I'm sold.

Mar 20th, 2014 11:05 pm

#112

boumbo: Sr. Member; Oct 16, 2007; 820 posts; 46 upvotes

Mar 20th, 2014 11:05 pm

Hi there,

I have a condo which I have been living for a while. I moved to my gf's house and is now renting my condo.
Is there a CRA form i need to fill to convert the rental condo from principal to rental ?
If such conversion exists and is done, does that mean my principal residence becomes automatically my gf's place?

Any other tax implications?

How does it work?

Mar 21st, 2014 5:36 pm

#113

bjserink: Member; Aug 16, 2004; 365 posts; 82 upvotes

Mar 21st, 2014 5:36 pm

yehenrytian wrote: ↑Thanks for your detail reply. But I think cases like mine are different, I found the following paragraph here: http://www.cra-arc.gc.ca/E/pub/tp/it533 ... P249_43576

Refinancing transactions
¶ 41. Where borrowed money is used to repay existing borrowed money or an amount payable for property acquired, the new borrowed money is deemed to have been used for the purpose for which the money previously borrowed was used or to acquire the property upon which amounts were owing, as the case may be, by virtue of subsection 20(3).

In other word I had the original mortgage on my property that I was going to rent it out, So the "refinanced" mortgage should be viewed is used as the same purpose as my previous mortgage, which is to buy the property. So the interest on the refiance mortgage should be tax deductible.

No, your case is not different. Your situation is IDENTICAL to that of Mrs Sherle. Don't be confused by the "Refinancing transactions" title on this section, it has nothing to do with refinancing your condo. It solely refers to using one loan to pay off another loan. And all this paragraph is saying, is that "If you pay off loan 1 using money from loan 2, the DIRECT USE of the funds for loan 2 becomes the same as what the funds for loan 1 were used for. For example, if you refinance your condo (loan 1) and use that money to buy new home (loan1-->personal use) and then take out a line of credit (loan 2) and use that to pay off some or all of loan 1, then the use of the borrowed money from loan 2 is also considered to be personal use, and is not eligible for tax deductions. Obviously you wouldn't bother to use a separate line of credit to pay off your mortgage, but if you did, that's how this rule would apply.

I think the key thing you are missing is the very first line, where it says "borrowed money is used to repay existing borrowed money". You are not using the refinance to pay off some other loan. There is nothing here that says that if you borrow money using the same collateral (in this case the condo), that it would take on the same direct use as other loans secured against the same collateral. The only way this rule could apply to you is if you refinance and then use that money to pay off a loan that is already tax-deductible (like a loan used to buy investments). If you directly use it to buy a new home, tough luck - the loan is not eligible for deductions. You don't have to believe me - but when the CRA audits you and fines you and makes you repay all the deductions, don't come crying to RFD!

Mar 21st, 2014 6:10 pm

#114

bjserink: Member; Aug 16, 2004; 365 posts; 82 upvotes

Mar 21st, 2014 6:10 pm

boumbo wrote: ↑Hi there,

I have a condo which I have been living for a while. I moved to my gf's house and is now renting my condo.
Is there a CRA form i need to fill to convert the rental condo from principal to rental ?
If such conversion exists and is done, does that mean my principal residence becomes automatically my gf's place?

Any other tax implications?

How does it work?

You have a unique situation, because assuming you have no ownership of your girlfriend's house, it will not count as a principal residence. Provided your girlfriend's house is in Canada, you actually have a choice now as to whether you want your condo to be treated as a principal residence or not. By filing a subsection 45(2) election, you can choose to keep it as principal for up to 4 years (if you keep it for longer, then you'll have to treat it as if the conversion occurred after 4 years). During this time, you cannot claim any CCA deductions (if you don't know what that is, you'd better do some more research), but the benefit is that when you go to sell the condo, you won't be taxed on any capital gains incurred during the time it is deemed to be a principal residence. The only reason not to file this election is if you believe the condo's market price will go down over the next four years - in that case you might want to have it NOT be your principal residence so you can claim the capital loss to offset some other capital gains you may have incurred in the year you sell it.
If you moved out in 2013, the 45(2) election should be sent in with your 2013 tax return (the one due this April). If you moved in 2014 then file it next year. If you actually moved prior to 2013, they might accept a late filing of the election provided you haven't claimed any CCA deductions on the condo.

This bulletin explains this special election in more detail: http://www.cra-arc.gc.ca/tx/tchncl/ncmt ... tml#N108E6

May 8th, 2014 1:54 am

#115

hpad06: Member; Jul 3, 2009; 326 posts; 54 upvotes

May 8th, 2014 1:54 am

Has anyone done it in Ontario? How did you handle land transfer tax?

Me and my wife are joint owner, do we sell or gift to the other half? Any lawyer has done such transactions?

Nov 30th, 2015 1:10 am

#116

monkeyxiii: Newbie; Feb 8, 2008; 3 posts; vancouver

Nov 30th, 2015 1:10 am

bjserink and others, I'm wondering if the squid manoeuvre can be done when a couple owns the property jointly by transferring ownership to themselves.

Here's the scenario I'm in. Husband and wife jointly owns house and live in it. They buy a new house with the intention of renting the old house.

Can we achieve the squid manoeuvre by:
1-husband gifts his share of old house to wife (this it tax exempt for gifts to spouses)
2-husband signs contract to buy new house
3-husband signs contract to buy old house back from wife at fair market value (say $500,000)
4-husband takes new mortgages against new house and/or old house to pay wife for old house ($500,000)
5-wife uses the $500,000 to pay for new house closing

Now the interest on the $500,000 borrowed should now be tax deductible on rental of the old house. Also, at the end of this sequence, the husband could then gift 50% of each house back to the wife.

Any opinions on whether the CRA will accept this scenario?

Note: I edited the sequence above to be simpler than my original post.

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