Building conversion – plan ahead!

Did you know that conversion or change of use can generate significant GST/HST and QST costs?

At a time when many municipalities are outlawing short-term rentals on their territory, many owners are deciding to change the vocation of their vacation properties, making them available to residential tenants or ceasing to rent them out altogether…

Legal framework for building conversion

In the Excise Tax Act (“ETA”) and the Quebec Sales Tax Act (“QSTA”), two terms are generally used: “conversion” and “change of use”. Considering the complexity of the tax rules, for practical purposes, even if these rules apply differently depending on the situation in question, we will retain the terminology “conversion” for the purposes of this publication.

To put it simply, a landlord who converts his entire commercial property to residential use (a tax-exempt activity) may have to pay the equivalent of GST and QST, calculated on the building’s fair market value (FMV), from the date the residential tenant moves in. In other circumstances, the landlord may instead be required to pay GST and QST calculated on the basic tax content of the property. Briefly, the basic tax content is a calculation that takes into account the taxes paid when the property was acquired, capital improvements made to the property and partial rebates claimed.

Case in point and other special features

Here’s an example from a real-life situation:

Mr. and Mrs. (“the owners”) owned a condominium that they rented as a vacation property through their own website for consecutive periods of less than one month;
Landlords were registered for GST/HST and QST and collected GST and QST on their rental income;
The owners had paid GST and QST when acquiring the property, and had also claimed all taxes payable at the time of purchase, resulting in a zero tax cost;
During the pandemic, due to difficulties in renting out their condominium, they decided to stop renting out and reserve the building for their personal use;
In so doing, the tax rules related to the conversion of an immovable were applied, creating a presumption that the owners were deemed to have sold the co-ownership to themselves and were required to remit to the tax authorities the GST and QST on the FMV of the immovable on the date of conversion.

In monetary terms, the tax rebate on the building’s FMV is non-negligible in the context of rising real estate prices. For example, for a building with a FMV of $500,000, the tax cost will be $74,875 ($25,000 GST and $49,875 QST). And let’s not forget the tax impact of changing the use of movable property. Furniture and equipment previously used more than 50% in the commercial activities of a tax-registered person and then used more than 50% for personal purposes must be subject to a tax rebate equal to the tax content.

Whether converted for personal use, or for residential rental to third parties, tax refunds for a residential building may be eligible. However, this requires a case-by-case analysis.

If you were unaware of these rules, you can take advantage of mechanisms such as the voluntary disclosure program to regularize your situation with the tax authorities.

There are other cases of building conversion:

– Complete conversion of a non-residential (commercial) building into a residential dwelling;
– Partial conversion of a space used for commercial purposes into a residential dwelling.

Each situation brings its own challenges, and sometimes even tax opportunities. For example, a 100% commercial building converted entirely to residential use may qualify for the 100% GST rebate for “purpose-built rental housing”.

Recommendations

Before changing the way you operate your commercial building, we strongly suggest you consult a professional expert in commodity taxes. Following an analysis, you may be able to find alternatives that reduce or eliminate the tax cost of converting your building.

Where conversion has taken place in the past without any tax having been remitted to the tax authorities, the voluntary disclosure program may allow you to waive payment of certain penalties to the tax authorities and reduce applicable interest.

Please do not hesitate to contact us for further information on sales taxes.

An article from our Consumption Taxes team