Buying a second property?
Congratulations! You have owned your first home for a while and now you are considering buying a second property – to move in or to rent out. Here are some tax issues to consider:
Suppose you want to move from your first property to live in a second property, and then rent out your first property. And suppose you want to take out a loan from your first property’s equity to buy a second property. In this scenario, the loan interest is generally not tax deductible because the loan is used to buy a personal residence property (i.e. the second property), even though the first property will be rented out. To make the loan interest deductible, it may be possible to create a series of legal transactions to have you sell and repurchase your first property (without triggering any property tax transfer nor any taxable capital gain). That way, the loan is used for the purpose of repurchasing the first property; hence, the loan interest will be tax deductible.
Marginal tax rates
Additional rental income coming from your second property may put you in a higher tax bracket, especially if you are already earning a lot of income. If you have a spouse or children 18 or over with relatively low income, it may be tax advantageous to share the beneficial ownership (and not necessary the title ownership) with them so that you could split the income and the future capital gain. Care should be taken to avoid tripping over certain tax regulations such as the attribution rules and the general anti-avoidance rule.
Change in use
Change in use rules allow a homeowner to elect the principal residence exemption on a property up to four years during which the property is rented out. For example, you lived in your home for two years, then you move out and rent out your home for four years, and finally you sell the home. The capital gains upon the sale of the house may be completely tax free if the appropriate elections are filed with Canada Revenue Agency. Reverse is also true if you first rented out the property for four years and then you live in it.
If you have to relocate to another city as a result of your current employment, you may be able extend the change in use election beyond four years. Note that you would have to remain a resident of Canada for tax purposes.
Principal residence exemption
If you own two properties, the principal residence exemption can only be designated on one property for each year that you live in and for the years covered under the change in use election. The exemption also applies if it is your spouse or child who lived in it. Since you may designate year 1 to the first property and year 2 to the second property, it is advisable to contact a Chartered Professional Accountant to help you determine the most tax advantageous selection.
If you would like to further discuss whether any of the above tax issues applies to you, please do not hesitate to contact us for a free consultation.