*This post was created in collaboration with Alpine Credits.
Buying a second home and renting out your current home can be a financially lucrative move. However, before you buy a second home and rent out the first, you need to understand the designation of primary residences in Canada and its associated tax implications.
Keep reading to learn the rules for buying a second home and renting out the first in Canada, and how each type of property is treated.
Key Takeaways
- You can designate your second home as a primary residence, so long as you live in it for 6 months or more of the year.
- You can only have one primary residence in any given year.
- If you make your first property into a rental property, it may be subject to capital gains tax. Any rental income will be taxable, but you may be able to deduct certain expenses.
Can You Buy A Second Property As Your Primary Residence?
You can buy a second home as a primary residence, that is if you meet the right criteria. To be able to designate your secondary property as a primary residence for tax purposes, you’ll need to move and live in the property for at least 6 months of the year.
You must also formally designate the home as your principal residence on your tax return using Form T2091 (IND), Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust).
Do note that you cannot claim two properties as your primary residence within the same tax year. Only one property can be designated as your primary residence in any given year.
| Definition of a Primary Residence To classify a property as a primary residence, you need to live in it for at least 6 months of the year. |
Rules For Buying A Second Home And Renting Out The First In Canada
You don’t have to notify the CRA right away when you convert your first property into a rental property. However, you will have to declare any rental income when you file your taxes.
Moreover, the property will no longer be eligible for the Principal Residence Exemption (PRE) during the period it’s being used for rental income. That said, you can claim certain expenses on your tax return such as property taxes, repairs, insurance and other expenses related to managing the rental property.
| Note: Every time you convert the use of your property, it’s considered to have sold at its fair market value and bought back at the same value, even though you don’t actually sell it. As a result, you may have to report a capital gain or loss for the year you change the property use. Learn more: Changes in use of your property |
Can You Have Multiple Primary Residences?
Only one property can be designated as your principal residence for each year. If you own multiple properties, you must choose which one to claim as your primary residence.
This is especially important to understand when you sell your second home. In this case, any capital gains from selling your secondary home would generally be taxable.
However, you may be able to take advantage of the “One Plus Rule“. This allows you to designate a new home as your principal residence for the year it’s sold, even if you already have another home that’s designated as your principal residence in that same year. This can save you a lot of money if you sell one home and purchase another in the same year.
How To Buy A Second Home As A Primary Residence?
The factors involved in buying a second home in Canada are the same as purchasing a primary residence:
Mortgage Stress Test
The mortgage stress test is a financial assessment used by lenders to determine if you can afford your mortgage payments if interest rates increase in the future or if you experience a sudden financial problem.
To pass the stress test, you must qualify for a home loan at a higher interest rate than the actual rate in your mortgage contract. Right now, the qualifying rate is either 5.25% or your contract rate plus 2%, whichever of the two is higher.
Learn more: The Canadian Mortgage Stress Test
Debt-To-Income (DTI) Ratio
Your debt-to-income ratio is a metric used by lenders to determine your ability to manage monthly payments and pay off your mortgage. More specifically, it compares your total monthly debt payments to your gross monthly income. Generally speaking, your DTI ratio should not exceed 44% to increase your chances of getting approved for a mortgage.
Credit Score
Your credit score plays a key role in the mortgage application process. A higher score will increase your odds of loan approval at lower rates and better terms. Ideally, your credit score should be at least 660 to get approved for a mortgage from a major financial institution in Canada.
Down Payment
A down payment is required for a mortgage in Canada. The amount you’ll need to pay upfront in the form of a down payment differs depending on whether the property is your primary residence or an investment property:
Second Home
The down payment on a second home can be as low as 5% if you’re buying it as a primary residence. However, this applies only if the value of the home is under $500,000. Down payment requirements increase as the price of the property increases.
For instance, homes valued over $500,000 and under $1 million require 5% down for the first $500,000, and 10% for amounts from $500,000 to $1 million. And homes valued over $1 million require at least 20% down.
Rental Home
Investment properties generally require a bigger down payment compared to primary residences. More specifically, you may need a down payment of at least 20% to finance a rental property.
Learn more: Your Guide To Mortgage Down Payments In Canada
Rental Income
Whether or not rental income can be used to qualify for a mortgage depends on how the property is classified:
If Buying As A Primary Residence
The Canada Mortgage and Housing Corporation (CMHC) allows homeowners renting out a second home to use anywhere from 50% to 100% of their rental income as a source of income when applying for a mortgage. However, there are specific guidelines that must be met to qualify for the full amount, including the following:
- You must reside in the home you’re renting out
- The rental unit must be self-contained with its own entrance
- The property cannot have more than 2 units
If Buying As A Rental
If you’re buying a home for the specific purpose of renting it out as an investment property, you can use up to 50% of the gross rental income to your total gross annual income when applying for a mortgage.
Learn more: Can You Use Rental Income To Qualify For A Mortgage In Canada?
Bottom Line
Purchasing a second home and renting out your first can be profitable, but there are specific distinctions and things to keep in mind. In particular, be mindful of owner occupancy and down payment requirements, as well as how rental income may be used to qualify for a mortgage.
