Tax Trap For Canadian Landlords: Temporary Use Of A Long-Term-Rental Property As An Airbnb May Trigger Unanticipated GST/HST Upon Sale

Introduction: The GST/HST Change-In-Use Rule under Subsection 206(2) of Canada's Excise Tax Act

Canada's Excise Tax Act imposes GST/HST on every "taxable supply made in Canada." A "taxable supply" essentially refers to any commercial activity, and it captures most business transactions—including the sale of real property. As a result, the sale of Canadian real property will typically trigger GST/HST liability unless the sale qualifies as an "exempt supply."

An "exempt supply" is a transaction for which the supplier (vendor) need not charge GST/HST but for which the supplier cannot claim input tax credits (ITCs). A complete listing of transactions that qualify as exempt supplies appears in Schedule V of Canada's Excise Tax Act.

One example of an exempt supply is the sale of a Canadian property that was used exclusively for long-term residential rentals. This exemption applies if the property meets the definition of "residential complex" under subsection 123(1) of the Excise Tax Act. A "residential complex" captures pretty much every type of residential-use property (building, condo unit, townhouse, etc.) unless the property is used as "a hotel, motel, inn, boarding house, lodging house, or similar premises" where "all or substantially all" (90 percent or more) of the rentals are for periods of less than 60 days. In other words, a long-term residential rental will typically not attract GST/HST when sold, but if that property was used as a hotel, motel, or other short-term rental, like an Airbnb, then the owner will generally sustain GST/HST liability when selling the property.

Subsection 206(2) of Canada's Excise Tax Act contains the GST/HST change-in-use rule, which covers situations where the property owner switches the property's use from long-term rentals, which are exempt supplies, to short-term rentals, which are taxable supplies. If it applies, the GST/HST change-in-use rule deems the property owner, for GST/HST purposes, to have repurchased the property at the time of the change in use and to have at that time paid GST/HST that equals the amount of any unrecovered GST/HST that the owner paid when actually purchasing the property.

The GST/HST change-in-use rule allows the property owner to claim the input tax credits that the owner couldn't previously claim at the time of purchasing the property. The property owner originally acquired the property to provide exempt supplies (long-term residential rentals), so the owner wasn't permitted to claim the ITCs at that time. But when the property owner subsequently begins to use the property for taxable supplies (short-term rentals), the GST/HST change-in-use rule permits the owner to now claim those previously unpermitted ITCs.

Although the GST/HST change-in-use rule brings about favourable tax consequences—namely, the ability to claim previously unavailable ITCs—the rule may also result in unexpected GST/HST liability for Canadian landlords who sell a property not long after switching it from a GST/HST-exempt long-term rental property to a taxable short-term rental property. The unanticipated tax consequences of the GST/HST change-in-use rule demonstrate why Canadians in the gig economy should seek advice from an expert Canadian GST/HST lawyer about the intricate GST/HST rules in Canada's Excise Tax Act.

This article analyzes the GST/HST change-in-use rule, and it discusses a situation where the change-in-use rule may cause unexpected GST/HST liability for Canadian landlords. It then concludes by offering pro tax tips from our skilled Canadian GST/HST tax lawyers.

The GST/HST Change-In-Use Rule: Subsection 206(2) of Canada's Excise Tax Act

Section 206 of Canada's Excise Tax Act contains several rules that increase or decrease the availability of ITCs when there's a change in use of a capital real property. These tax rules apply to GST/HST registrants who are not individuals (i.e., corporations) and to public service bodies that file a section 211 election. (The election under section 211 of the Excise Tax Act allows public services bodies to treat certain supplies of real property that would otherwise be exempt supplies as taxable supplies.)

The GST/HST change-in-use rule in subsection 206(2) of Canada's Excise Tax Act captures situations where a GST/HST registrant acquired a real property with the initial intent to use that property exclusively for exempt supplies, such as long-term residential rentals. (A long-term residential rental qualifies as an exempt supply under section 6 of Part I of Schedule V of Canada's Excise Tax Act. In particular, section 6 exempts the supply of a residential complex or residential unit, such as a condominium, if (i) the supply occurs by way of lease, licence, or similar arrangement for the purpose of occupancy as a place of residence by an individual and (ii) the arrangement gives the same individual the right to continuous occupancy for at least a one-month period.)

Subsection 206(2) applies when a GST/HST registrant acquires a real property for a purpose other than as a capital property for the registrant's taxable supplies and later begins using the property as a capital property for the registrant's taxable supplies. The provision reads as follows:

For the purposes of this Part, where a registrant last acquired real property for use as capital property of the registrant but not for use in commercial activities of the registrant and the registrant begins, at a particular time, to use the property as capital property in commercial activities of the registrant, except where the registrant becomes a registrant at the particular time, the registrant shall be deemed

to have received, at the particular time, a supply of the property by way of sale; and
except where the supply is an exempt supply, to have paid, at the particular time, tax in respect of the supply equal to the basic tax content of the property at the particular time.

Hence, the subsection will apply if the following three conditions are satisfied:

A GST/HST registrant acquired a real property for use as the registrant's capital property but not for commercial activities (e.g., for use in exempt supplies or for use in entirely non-commercial activities);
The registrant later begins using the property as a capital property for commercial activities (i.e., for use in taxable supplies); and
The registrant didn't become a registrant at the time that the registrant began using the property for commercial activities (i.e., the registrant obtained GST/HST registration before the registrant started using the property for taxable supplies).

Where a GST/HST registrant acquires a real property exclusively for exempt supplies, the registrant cannot claim an input tax credit for the GST/HST that the registrant paid to buy the property. This is because the registrant didn't acquire the real property for use in taxable supplies.

But if the GST/HST registrant later begins using the real property for taxable supplies, such as short-term Airbnb rentals, then the GST/HST change-in-use rule in subsection 206(2) allows the registrant to claim, at the time that the registrant begins using the real property for taxable supplies, an input tax credit. The amount of ITC is based on two things: (1) the amount of the GST/HST that the registrant paid to acquire the real property and (2) the extent to which the registrant is now using the real property for taxable supplies.

The GST/HST change-in-use rule accomplishes this by deeming the GST/HST registrant, for GST/HST purposes, to have repurchased the property at the time of the change in use and to have at that time paid GST/HST that equals the amount of any unrecovered GST/HST that the registrant paid when actually acquiring the property. In other words, the GST/HST change-in-use rule allows the registrant to claim ITCs and thereby recoup the GST/HST costs that the registrant incurred to acquire the property. By doing so, the GST/HST change-in-use rule effectively puts the registrant in the same tax position that the registrant would have attained had the registrant initially bought a property to make taxable supplies.

The GST/HST Change-In-Use Rule & Unanticipated GST/HST Upon Sale

Yet while the GST/HST change-in-use rule permits registrants to claim previously unavailable ITCs, the rule may also result in unexpected GST/HST liability for Canadian landlords who sell a property not long after switching it from a GST/HST-exempt long-term rental property to a taxable short-term rental property.

For example, consider the following scenario:

An incorporated landlord buys a used residential condo unit.
Over the next 9 years, the landlord uses the condo unit exclusively for long-term rentals.
In year 10, the landlord lists the condo unit on Airbnb, renting out the condo to several tenants for no more than a few days each.
In year 11, the landlord sells the condo unit.

For the first 9 years of ownership, the landlord used the condo unit exclusively for long-term rentals, which meant that the landlord's rental income was GST/HST exempt. In year 10, the landlord triggered the GST/HST change-in-use rule under subsection 206(2) of the Excise Tax Act. But the landlord paid no GST/HST to buy the condo because it was a used property when the landlord purchased it. Thus, the landlord gains no tax benefits from the change-in-use rule: The landlord doesn't gain ITCs because the landlord paid no GST/HST when buying the property.

Moreover, the change-in-use rule deemed the landlord to have acquired the condo unit in year 10, when the landlord began using the property for taxable supplies (i.e., the short-term Airbnb rentals). Because the landlord used the condo unit solely for taxable supplies from the date of the deemed acquisition to the date of the sale, the condo unit doesn't meet the definition of "residential complex" under subsection 123(1) of the Excise Tax Act. As a result, the sale of the condo unit was itself a taxable supply and therefore subject to GST/HST.

In other words, although the landlord used the condo unit exclusively for long-term rentals during the first 9 years of ownership, a single year of short-term rentals caused the condo unit to lose its GST/HST-exempt status. When selling the condo unit, the landlord will consequently incur GST/HST liability, which may very likely come as a surprise.

This is exactly what happened to the taxpayer in 1351231 Ontario Inc. v. The King, 2024 TCC 37. In this case, a corporation purchased a used residential condominium unit. Over the next nine years, the landlord corporation rented out the condo unit to several tenants under a series of long-term residential leases, which meant that the rental income was GST/HST-exempt for the landlord. In the tenth year, the landlord corporation started renting out the condo unit on Airbnb. In year 11, the landlord sold the condo unit. Although the condo unit was briefly used as an Airbnb before the sale, it had been used as a long-term rental throughout the previous nine years. As a result, the landlord decided to treat the sale of the condo as GST/HST exempt.

The Canada Revenue Agency later audited the landlord for GST/HST. The CRA's GST/HST auditor concluded that the condo sale was a taxable supply and reassessed the landlord for $80,000 in GST/HST on the sale.

The Tax Court of Canada ultimately agreed with the Canada Revenue Agency and upheld the landlord's $80,000 GST/HST reassessment.

During the hearing, the landlord's Canadian tax-litigation lawyer argued that the sale of the condo unit was tax exempt because the condo unit still met the met the definition of "residential complex" in subsection 123(1) of Canada's Excise Tax Act. The landlord's Canadian tax-litigation lawyer pointed out that the definition of "residential complex" contained no timing test, so the criteria in that definition should be applied over the entire ownership period. The landlord exclusively used the condo unit for long-term leases during 9 of the 11 years of ownership. Therefore, according to the landlord's Canadian tax-litigation lawyer, the condo unit met the definition of "residential complex" and the sale of the unit qualified as a tax-exempt supply.

The Tax Court rejected this argument for two reasons. First, the court disagreed with the argument's premise that the definition of "residential complex" should be applied over the entire ownership period. The court held that the provisions of Canada's Excise Tax Act required the court to determine whether the condo unit met the definition at the time of the sale, and at the time of sale, the condo unit didn't meet the definition because it was being used for short-term Airbnb rentals.

Second, the Tax Court found that, even if the landlord's Canadian tax-litigation lawyer was correct that the definition of "residential complex" should be applied over the entire ownership period, the sale would still be a taxable supply because of the GST/HST change-in-use rule in subsection 206(2) of Canada's Excise Tax Act. The GST/HST change-in-use rule deemed the landlord to have acquired the condo unit in year 10, when the landlord began using the property for short-term Airbnb rentals. This deeming rule therefore created a new ownership period—that is, the period from the date of the deemed acquisition in year 10 to the date of the sale in year 12. The landlord had used the condo unit solely for taxable supplies throughout this notional ownership period. So, even if the definition of "residential complex" should be applied over the entire ownership period, the condo unit still wouldn't meet this definition, and the sale of the condo unit would still be a taxable supply and subject to GST/HST.

The Tax Court's 1351231 Ontario Inc. decision is pending appeal as of September 2024. Still, this case demonstrates why Canadian landlords should seek tax advice from a skilled Canadian GST/HST lawyer about the Excise Tax Act's complex GST/HST rules. Even an apparently subtle change in use—such as from a long-term rental to a short-term rental—can lead to unexpected tax traps. In 1351231 Ontario Inc, the landlord used the condo unit exclusively for long-term rentals during the first 9 years of ownership, yet a single year of short-term rentals through Airbnb caused the condo unit to lose its GST/HST-exempt status. Canadian landlords who sell a rental property under similar conditions may be shocked to learn that they consequently owe GST/HST to the Canada Revenue Agency.

Pro Tax Tips – The GST/HST Change-In-Use Rule, The Availability of ITCs & The Possibility of GST/HST Liability

The GST/HST change-in-use rule in subsection 206(2) of Canada's Excise Tax Act comes with benefits and drawbacks. On the one hand, the GST/HST change-in-use rule allows GST/HST-registered corporations to claim previously unavailable ITCs and thereby recoup the GST/HST costs that the registrant incurred to buy a property that was initially used for non-commercial purposes or for exempt supplies. But on the other hand, the GST/HST change-in-use rule offers no tax advantage if the registrant didn't pay GST/HST when buying the property. Moreover, in some cases, the GST/HST change-in-use rule may cause unexpected GST/HST liability when the registrant sells the property—for example, in cases like 1351231 Ontario Inc. v. The King, 2024 TCC 37, where a single year of short-term Airbnb rentals caused a condo unit to lose its GST/HST-exempt status.

All Canadian property owners and investors should consult with an expert Canadian GST/HST lawyer. Our experienced Canadian GST/HST lawyers can offer tax-planning strategies, warn you about potential tax issues when using property for business income, and ensure that you understand all your GST/HST and income-tax obligations. This includes information on input-tax-credit eligibility, GST/HST liability for Airbnb rentals, and the treatment of rental income and capital gains from property sales. The CRA's tax auditors target rental properties and real-estate transactions, and the resulting tax assessments can often reduce the expected financial benefits of these types of ventures for Canadian homeowners. For advice on avoiding or minimizing the possibility of an unfavourable tax reassessment by the Canada Revenue Agency, contact our Canadian GST/HST lawyers today.

FREQUENTLY ASKED QUESTIONS

What is the GST/HST change-in-use rule?

What's the purpose of the GST/HST change-in-use rule in subsection 206(2) of Canada's Excise Tax Act?

The GST/HST change-in-use rule allows the property owner to claim the input tax credits that the owner couldn't previously claim at the time of purchasing the property. The property owner originally acquired the property for a non-commercial purpose or to provide exempt supplies (e.g., long-term residential rentals), so the owner wasn't permitted to claim the ITCs at that time. But when the property owner subsequently begins to use the property for taxable supplies (e.g., short-term rentals), the GST/HST change-in-use rule permits the owner to now claim those previously unpermitted ITCs.

Are there any drawbacks or disadvantages to the GST/HST change-in-use rule in subsection 206(2) of Canada's Excise Tax Act?

I own some real estate in Canada. It's currently a personal-use residential property, but I want to start using it as an Airbnb. What do I need to know?

The GST/HST rules in Canada's Excise Tax Act are complex—especially those concerning real-property transactions. If you own a Canadian real property that you plan on selling or using for a different purpose, seek advice from a competent Canadian GST/HST lawyer. For example, in 1351231 Ontario Inc. v. The King, 2024 TCC 37, a taxpayer received an $80,000 GST/HST bill from the Canada Revenue Agency's tax auditors because the taxpayer turned an otherwise exempt property into a taxable property by listing it on Airbnb. Although the case is pending appeal in September 2024, it still underscores the importance of ensuring that you understand the tax implications when you change the use of a Canadian real property. Even an apparently subtle change in use—such as from a long-term rental to a short-term rental—can lead to unexpected tax traps. Our experienced Canadian GST/HST lawyers can offer tax-planning strategies, warn you about potential tax issues when using property for business income, and ensure that you understand all your GST/HST and income-tax obligations. This includes information on input-tax-credit eligibility, GST/HST liability for Airbnb rentals, and the treatment of rental income and capital gains from property sales. The CRA's tax auditors target rental properties and real-estate transactions, and the resulting tax assessments can often reduce the expected financial benefits of these types of ventures for Canadian homeowners. For advice on avoiding or minimizing the possibility of an unfavourable tax reassessment by the Canada Revenue Agency, contact our Canadian GST/HST lawyers today.

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