Have You Changed the Use of Your Home? Here’s the CRA Election That Could Save You Big: 45(2) & 45(3) Election (Part 7 of Capital Gains series)
- Elkhanagry Accounting
- Sep 15
- 6 min read
Updated: Sep 17
Table of Contents
Introduction: Turning Knowledge into Real Savings
At Elkhanagry Accounting, we often say that tax planning isn’t just about filing forms; it’s about unlocking opportunities hidden in the Income Tax Act (ITA).
One of our clients purchased a Toronto condo, lived in it for one year, then moved back in with his parents. To avoid leaving the property vacant, he rented it out. Four years later, he sold the condo and realized a significant capital gain of approximately $200,000.
Ordinarily, those four rental years would not qualify for the Principal Residence Exemption (PRE), which could have created a massive tax bill. But because we knew about Section 45(2) of the ITA, we filed an election that allowed him to treat the condo as his principal residence during those years. The result? He saved himself tens of thousands in tax — all because of one little-known provision.
This blog explains how the 45(2) and 45(3) elections work, when they apply, and why they’re one of the most powerful tools for homeowners who rent or move back into their properties.
What is a Change of Use?
A change of use occurs when you convert a property from one type of use to another; typically from personal use (principal residence) to income-producing use (rental), or the reverse.
The Default CRA Rule: Deemed Disposition
Under subsection 45(1) of the Income Tax Act (ITA), a change of use triggers a deemed disposition of the property at its fair market value (FMV), followed by an immediate reacquisition at the same value.
If converting personal → rental: You are considered to have sold the property at FMV, which can create an immediate capital gain if the value has risen since purchase.
If converting rental → personal: The property is deemed sold at FMV, which can crystallize deferred gains on the rental years.
This deemed disposition can result in unexpected tax bills even though no cash has been realized from an actual sale.
Why the Rules Exist
The CRA uses this rule to prevent taxpayers from indefinitely deferring capital gains by changing how they use a property. Without it, individuals could shift properties between rental and personal use without ever recognizing appreciation in value.
The Planning Opportunity
Fortunately, subsections 45(2) and 45(3) were introduced to provide relief in specific situations. These elections allow taxpayers to defer gains and, in some cases, extend the Principal Residence Exemption (PRE). With the right strategy, these rules can transform what would have been a taxable event into significant tax savings.
The Power of Section 45 Elections (45(2) & 45(3))
When you change the use of a property, the default rule under subsection 45(1) of the Income Tax Act (ITA) is that you are deemed to have disposed of it at its fair market value (FMV). This can trigger capital gains tax immediately, even though you haven’t actually sold the property.
To avoid this outcome, the ITA allows two special elections under s.45(2) and s.45(3).
45(2) Election – Moving Out of Your Home
When it’s used: This applies when you move out of your principal residence and begin renting it out. Normally, that would trigger a deemed sale, but filing the election defers the tax.
45(3) Election – Moving Back Into a Rental
When it’s used: This applies when you take a property that was previously a rental and move back in as your home. Normally, that change would trigger a deemed sale, but the election defers the tax until the actual sale.
General Benefits of 45(2) & 45(3) Elections
1. Deferral of Capital Gains
Without these elections, a deemed disposition under s.45(1) could create a capital gain on the date of conversion. Elections under s.45(2) or s.45(3) defer this tax until the property is actually sold. This allows homeowners to control the timing of when gains are recognized.
2. Extension of the Principal Residence Exemption
Both elections help preserve valuable access to the Principal Residence Exemption (PRE).
Together, these provisions effectively let homeowners “add back” 4 PRE years that would otherwise be lost, often sheltering hundreds of thousands of dollars in capital gains from taxation.
3. Flexibility in Life Transitions
People’s circumstances change; moving for work, renting out a condo while living with parents, downsizing, or inheriting property. These elections allow for flexibility without punishing taxpayers for temporary life changes.
Conditions, Limits, and Pitfalls
While the 45(2) and 45(3) elections can generate huge savings, there are strict conditions:
1. Deadlines
45(2) election: Must be filed by the due date of your income tax return for the year the change of use occurs.
45(3) election: Can be filed in the year you ultimately sell (dispose of) the property, not at the time of change.
2. Late-Filed Elections
CRA may accept late-filed elections under taxpayer relief.
More common for 45(2), considered case-by-case for 45(3).
Penalties may apply under Regulation 600:
Lesser of $8,000 or $100 per month from original due date.
Example: If filed 12 months late → $1,200 ($100 × 12).
3. Maximum 4 Years
45(2) allows you to keep the Principal Residence Exemption (PRE) for up to 4 extra years while the property is rented.
You must be resident (or deemed resident) in Canada during those years.
4. One Principal Residence Rule
Only one property per family unit can be designated as a principal residence for each year.
5. No CCA
You cannot claim Capital Cost Allowance (CCA) on the property during rental years.
If any CCA is claimed (by you, a spouse/CLP, or a trust for your benefit), the election is deemed not valid.
6. Partial Changes in Use
Since March 19, 2019, both 45(2) and 45(3) elections are available for partial changes in use.
Example: Renting out a basement suite while still living in the rest of the home.
7. Documentation
Keep proper records of Fair Market Value (FMV) at the time of conversion.
FMV determines the adjusted cost base (ACB) and ultimate gain on sale.
Maintain supporting documents: appraisals, rental agreements, and proof of residence.
Case Study: Joe Shmoe Saves Big: The 45(2) Election in Action
History
Owner: Joe Shmoe
Property: Purchased in January 2018 for $290,000
Use: Principal residence until the end of 2018, then converted to rental
FMV at 2018 (conversion): $300,000
FMV at 2023 (sale): $500,000
Assumed Tax Rate: 50%
Without 45(2)
In 2018, there is a deemed disposition at conversion.
Gain = $300,000 – $290,000 = $10,000, which is fully sheltered by the Principal Residence Exemption (PRE).
The property’s new ACB is now $300,000.
At sale in 2023:
Gain = $500,000 – $300,000 = $200,000.
Since the property was a rental, this portion does not qualify for PRE.
Taxable capital gain = $200,000 ÷ 2 = $100,000.
Tax at 50% = $50,000.
With 45(2)
By filing the election, Joe continues to treat the property as his principal residence for up to 4 extra years (plus the “+1” rule, for a total of up to 6 years).
This means the entire period (2018–2023) still qualifies for PRE coverage.
Assuming: (i) no other property was designated PR by the family unit for those years, and (ii) the taxpayer remained resident in Canada
At sale in 2023:
Total gain = $500,000 – $290,000 = $210,000.
Entire gain is fully sheltered by PRE.
No tax payable.
CRA References & Key ITA Sections
Income Tax Act:
CRA Publications:
Contact Us!
Maximize the value of your real estate with the right tax strategies. The 45(2) and 45(3) elections can mean the difference between paying tens of thousands in tax or walking away with those savings in your pocket. But these elections come with strict conditions, deadlines, and CRA limitations that can be easy to miss without expert guidance.
Our team of experienced tax professionals specializes in complex real estate planning and capital gains strategies. We can help you:
Assess Eligibility: Determine if your property qualifies for the 45(2) or 45(3) election and whether it aligns with your broader tax goals.
Avoid Costly Mistakes: Ensure elections are filed properly and on time, avoiding penalties and disqualification.
Optimize Tax Savings: Integrate these elections with the Principal Residence Exemption, rental income reporting, and long-term capital gains planning to minimize your lifetime tax burden.
Failing to plan properly can result in losing access to thousands in tax savings — just like our client who nearly faced a huge tax bill before we stepped in. With our expertise, you’ll have the confidence to make the right moves and protect your wealth.
Contact us today for a personalized consultation. Whether you’re renting out a former home, moving back into a rental, or planning a future sale, we’re here to guide you every step of the way. Together, we’ll turn complex tax law into strategic savings that set you apart financially.
Disclaimer
This article provides general information that is current as of the posting date and is not updated, which means it may become outdated. The content is not intended to provide accounting, tax, or financial advice and should not be relied upon as such. Tax and financial situations are unique to each individual and may differ from the examples discussed in this article. For personalized advice, please consult a qualified tax professional.
