One Comment About Taxation – New Mortgage Rules That Encourage Existing Homeowners to Become Landlords Comes With Tax Traps!

 

Over the last number of years, the federal Liberal government has introduced a number of measures aimed at increasing housing supply.

 

One of the new measures announced last week would change mortgage insurance rules to enable existing homeowners to take on more debt in order to create rental units within existing homes.  The new units must be fully self-contained units (e.g., basement suites with separate entrances, laneway homes) and meet municipal zoning requirements. In addition, there cannot be more than four dwelling units including the existing unit.

 

I will stay in my “tax lane” and not address the obvious insanity of enticing an already indebted population into taking on even more debt with the carrot being the “incredible advantages” of becoming a landlord.  Obviously, no one in Canada has ever lost money by over-leveraging to become a landlord.

 

What I will comment on, however, is the complete disregard for the myriad of complicated tax issues that come with such a housing conversion.

 

The first tax consideration that must be considered is the “change in use” rules of the Income Tax Act.  The conditions required for the newly announced mortgage rules, which requires a “change in use” from a wholly personal-use property to a partial rental property, would likely cause the change in use rules to apply.  If so, the proportionate share of the property’s fair market value (usually computed by reference to area) that is now a rental property is deemed disposed of at fair market value.  Many Canadians are surprised by these income tax rules since there is no actual disposition of the home.

 

Such a deemed disposition will usually result in a gain that can often – but not always, depending on the facts – be offset by the individual’s available principal residence exemption if the property is held personally.

 

There are some elections available in the right circumstances whereby the above gain can be deferred but it is important to ensure that the election is timely filed and properly considered to avail oneself of the deferral.

 

The Canada Revenue Agency discusses these rules in Income Tax Folio S1-F3-C2.  Paragraph 2.59 of the Folio states:

 

It is the CRA’s practice not to apply the deemed disposition rule, but rather to consider that the entire property retains its nature as a principal residence, where all of the following conditions are met:

 

1. The income-producing use is ancillary to the main use of the property as a residence;
2. There is no structural change to the property; and
3. No CCA is claimed on the property.

 

However, it is doubtful that the above conditions could be met if the homeowner is making a structural change to add rental suites and obtaining financing to do so.

 

The second consideration is that from the conversion date forward, the taxpayer will now be obligated to report any rental income.  The taxpayer should be entitled to deduct most expenses related to the new rental operation – such as the newly incurred interest costs on the debt – subject to a myriad of detailed rules and restrictions contained in the Act.  What about the ability to claim depreciation on the house (or “capital cost allowance” as it is called in tax matters)?  Sure, but only on the portion of the house that is rented.  However, CCA claims can complicate the elections for deferrals previously discussed and eligibility for future principal residence exemption claims when the property is eventually sold.

 

The third consideration is that a future principal residence exemption claim on the eventual disposition of the property would only be available on the personal-use portion of the property, not the rental portion. Be mindful of that.

 

The fourth consideration is that there could be GST / HST consequences from the conversion. As noted by renowned commodity tax expert, Noah Sarna, there could be a significant GST/HST liability for people who construct a laneway home and rent it to a long-term tenant. The same outcome generally doesn’t flow from a basement suite.  The CRA discusses these issues in GST/HST Info Sheet GI-168.

 

Confused yet?  You’re not alone.  These areas of income and commodity tax confuse even the most seasoned experts who must carefully look at the resulting consequences of such conversions.  I have spent years in my practice explaining to homeowners the tax complications of converting a principal residence.  It is not simple.

 

It is irresponsible for governments to release proposals with a lot of fanfare (to create the perception that they are solving a housing crisis) without any mention of the tax and other complications that will undoubtedly be created.  While I’m all for government incentives to help create entrepreneurs, it needs to be done in a responsible manner with consequences fully thought through.

 

In my experience, landowners and developers understand housing issues and concerns better than most.  A lot of them tell me that the main reason for the lack of affordable housing is an inability to properly plan for and implement urban boundary expansion.

 

This latest proposal – the push to turn homeowners into landlords – simply adds to the mountain of government interventions in our housing markets such as the recent push for intensification within already crowded urban settings, the introduction of bans and taxes on foreign owners and numerous other silly taxation provisions.

 

Given such, is more government intervention the answer? In my view, absolutely not.  As renowned economist, Thomas Sowell has stated:

 

Contrary to the vision of the left, it was the free market which produced affordable housing – before government intervention made housing unaffordable.  

 

I think there is a lot of truth in that statement.  While some government intervention is inevitable, it needs to be thoughtful.

 

In the present case, I hope and trust that the people who go into debt to “take advantage” of this latest great program will be well advised on both the financial and taxation consequences. It’s not pretty.  And this latest program is certainly not a game-changer.

 

One Comment About Leadership – Leaders, Do You Need to “Burn Your Ships”?

 

Over two decades ago, I was in a professional situation, “Situation A”, that I had spent a lot of time planning for but was always unsure that it was an appropriate thing to do.  After pulling the trigger, I had almost immediate regrets and was not happy.  After about 6 months, I decided that Situation A required a change of course.  In fact, before I entered into Situation A, I had already planned for such a possibility – “Plan B” – in case Situation A didn’t work.  When I moved away from Situation A, I executed on the Plan B that I drawn out.

 

I often do that with strategic planning.  In other words, I’ll have a “Plan A” and a “Plan B”.  And sometimes a “Plan C”.  That kind of planning has worked well for me in many situations.

 

However, the “Plan B” in the situation I was dealing with almost two decades ago was frantic and came with many unforeseen obstacles.  I was lamenting about it with a person in a peer-to-peer learning group that I was in at that time.  That person said “Well, Kim, you didn’t burn your ships with your Plan A”.  

 

I had no idea what he was talking about.  He asked me to pretend that the Situation A that I was dealing with was like an island in the middle of the ocean that I had taken a ship to.  Upon arriving, I immediately set fire to the ship.  In other words, there was no escape route and I would need to make the situation on the tiny island work.  I had better be able to learn how to gather food, make fire, find fresh water, and other necessities since to not do so would mean I wouldn’t survive.  If the boat was sitting on the shore, I would be able to leave the island and search for other areas to thrive.

 

Once I thought about Situation A in the above light, it was clear to me that I was never really comfortable with it and was always looking for ways to execute on Plan B.  In other words, I was never committed to Situation A. I didn’t burn my ships and make it work.  And truth be told, I was never really enamored with Situation A.  If I had thought about the ship burning analogy before entering into it, I likely would have never entered into Situation A.

 

Since that time, I often think about strategic situations that have been presented to me as to whether or not the situation requires the ships to be burned.  If so, I think very, very carefully about what the plan and related commitment is.

 

Leaders, are you facing situations that would be better if you burned the ships?  Or do you always have an escape route?

 

(“Burn your ships” is a modern-day expression for the 1519 scuttling of the Spanish explorer’s – Hernan Cortes – fleet upon landing in Mexico).

 

One Comment About Economics: Surprise!!  Canada’s Deficit For This Coming Year Will Be Higher Than Budgeted 

 

The 2024 Federal Budget projected that the upcoming fiscal year for the Canadian budget would produce a deficit of $39.8 billion.  Well, the latest Parliamentary Budget Officer Report  dated October 17, 2024 predicts that this year will produce a budgetary deficit of $46.4 billion.  That is a difference of $6.6 billion or 16.5% of the original estimate.  That is material.

 

Should we be surprised by this?  Absolutely not.  Our current federal government has proven themselves – over and over and over again – to be fiscally irresponsible. Increasing deficits mean increased public debt charges as well.  Public debt charges provide zero net benefit to Canadian society.

 

Change and fiscal responsibility cannot come soon enough.

 

Bonus Comment – Quote From Sir Winston Churchill – Former British Prime Minister – About Dealing With Uncertainty

 

“Burn the boats as you enter the island and you will take the island”.

 

Leaders, are you burning your ships when it is needed?

 

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