Laneway Housing and the Tax Man!
by Richard Bell
Laneway housing is becoming a popular solution for Vancouver homeowners wanting to provide affordable living for family members, be they parents or children. It is also becoming a popular investment for homeowners who elect to rent the laneway home thereby earning rental income. Under Vancouver bylaws it is now possible to have three separate living accommodations on most properties: the main home, a rental suite in the main home and a laneway home. A win for homeowners and a win for the City as it creates more rental stock.
But for homeowners building a laneway home for rental income there may be a surprise awaiting them when they sell the property. One of the biggest tax breaks for Canadians is the principal residence exemption. If you bought a home 10 years ago for $500,000, used it as your principal residence and designated it as such for income tax purposes throughout that time, and sell it today for $1.2 million – that $700,000 gain is tax free.
However, when you build a laneway home for rental purposes the tax man will likely treat that as a partial notional disposition of your property resulting in the creation of two “separate properties” for tax purposes even though there is only one “legal” property. Assuming the entire property fully qualified for the principal residence exemption at the time the laneway home was constructed and rented out, there would typically be no tax liability triggered on the notional disposition. Going forward, the laneway home will have a value for tax purposes based on the cost of construction and the value of the portion of the land used for the laneway home and rental activity. It is important that homeowners keep records of all cost associated with the laneway home and the value of the land at the time the laneway was built.
Ultimately when the property is sold, or is deemed to be sold as a result of death of the property owner, there will likely be capital gains payable. For example, if you build a laneway house for $300,000 and the prorated portion of the land is worth $250,000 for a total cost base of $550,000 and when you sell the total value is calculated to be $750,000 there is a $200,000 gain and tax will be payable on 50% of the gain. The calculation might be a bit challenging but the tax man has the upper hand because whatever he says goes until an appeal decides otherwise.
And remember during the period of ownership you need to claim your rental income but you can offset expenses against that income such as mortgage interest and a prorated portion of taxes related to the laneway home. And over time as you make repairs or improvements to the laneway home your cost base will change.
This article focuses on potential capital gains associated with laneway homes. There may also be GST issues with leased laneway homes.
So the best advice, is to get professional advice.