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Written by: Wendy Seet, CPA, CA
The popularity of detached secondary dwellings has continued to grow throughout the Lower Mainland ever since the City of Vancouver approved them in 2009 to promote affordable housing. While referred to as “laneway homes” in this article, these dwellings are also known as “coach houses”, “garden suites”, “garden cottages”, “carriage houses” or “granny flats” depending on their location.
Laneway homes are typically rented out to supplement the cost of living in the Lower Mainland, but are also used to keep aging parents or disabled adult children independent yet close, or to assist adult children who cannot afford to purchase their own home.
The income tax implications of building and renting these homes may surprise homeowners, particularly with respect to the principal residence exemption (“PRE”).
The PRE can be used by Canadian-resident individuals to shelter their gain on the sale of a principal residence. However, the exemption is only available to a family for one housing unit in any year and the home must be “ordinarily inhabited” by the owner or certain family members (generally, spouse and children).
Despite both homes being on the same title and on the same land which cannot be subdivided, the introduction of a self-contained laneway home with its own entrance and separate electrical, plumbing and heating systems brings into question the ownership of more than one housing unit for tax purposes. “Housing unit” for PRE purposes is not defined in the ITA. However, based on its ordinary meaning and the Canada Revenue Agency’s (“CRA”) administrative position, a laneway home would be considered a separate housing unit. In contrast, a suite within the main home is considered by the CRA to retain its nature as a principal residence where the income-producing use is ancillary to the main use of the property, there is no structural change and no capital cost allowance (tax-equivalent of amortization) has been claimed.
After construction is completed and the laneway home is rented to arm’s length parties, it would no longer meet the “ordinarily inhabited” rule for the PRE. It would also trigger the “change of use” rules and cause a deemed disposition for tax purposes – of the laneway home and the land that “contributes to the use and enjoyment of the housing unit as a residence”. Any portion of the gain that is not sheltered by the PRE will be taxable – this could be significant depending on the number of years that cannot be designated for the PRE and the growth in value of the property since acquisition.
Furthermore, the PRE designation relates to the entire property. Upon subsequent sale of the property, the years designated upon the change in use of the laneway home are no longer available to be claimed – this could also trigger a significant gain on the eventual sale despite the “bump” in the cost of the portion of the property used for the laneway home.
Homeowners should keep all records associated with the expenses of building the laneway home in order to substantiate the tax cost of the property. When making the PRE designation, taxpayers should also consider the impact on the future sale of other properties that qualify for the PRE during the same years, for example any vacation homes.
While the lure of additional rental income may be appealing, professional tax advice should be sought when contemplating adding to your property.
The above content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent changes. Professional tax advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.