Old Ottawa South: a family home with a suite in the basement

Old Ottawa South is a neighbourhood of family houses close to things students and young professionals want: it sits between the Rideau Canal and the Rideau River, Carleton University is a short walk across the water, and Bank Street runs its length with everything on it. That combination makes the basement suite almost a local institution. A family buys the house, finishes the lower level, and rents it to a Carleton graduate student or a young couple. The rent helps carry the mortgage. What most owners do not realise is that the same suite creates two distinct tax questions, one every year and one only when they sell, and the second is the one that can cost real money.

The answer to the second question, stated up front: a family that rents part of the home it lives in, makes no structural change to create the suite, and claims no capital cost allowance on the building normally keeps the full principal residence exemption on the whole property. Break any one of those three and the rented share of the house is treated as having changed use, which means a notional sale of that portion now and a taxable slice of the gain later. Since 2019 there is an election that can switch that deemed sale off, but it has to be filed with the return for the year the use changed.

The rental income, and the deductions that come with it

The yearly question is straightforward once you know it exists. Rent from the basement is income and has to be reported, but only the profit is taxed, and a fair share of the costs of running the house comes off against that rent. Because the suite is part of your own home, the expenses are split between the rented portion and the part you live in, usually by floor area, sometimes adjusted for shared space. The whole calculation lands on the statement of real estate rentals attached to the personal return.

So if the suite is a quarter of the house by area, roughly a quarter of the mortgage interest, property tax, heat, hydro, water, insurance, and general upkeep is deductible against the rent, along with the full cost of anything that belongs only to the tenant’s space, such as repainting the suite or fixing its appliances. A repair that keeps the property in the condition it was in is deductible now; an improvement that betters it, like finishing the basement in the first place or replacing the old kitchen with a better one, is a capital cost handled differently. One deduction owners are often told to take and should think twice about is capital cost allowance on the building itself, depreciation against the rent. It lowers tax today, but it can jeopardise part of the principal residence exemption on that portion of the home, which brings us to the part that actually matters.

One rule has changed recently and it catches owners near Carleton in particular. Where a residential property is rented out short-term in a municipality that prohibits or licenses such rentals, and the operator is not compliant with those local rules, the deductions against that short-term rental income are denied. A suite rented to a student on a normal lease is not affected. A suite listed by the night without meeting the City of Ottawa’s requirements can be, and the denial applies to the expenses rather than to the income, which is the expensive way round. The rules Ontario applies to residential tenancies are a separate question from the tax treatment, but a suite that is properly tenanted under a lease is easier to defend on both fronts at once.

The principal residence exemption is what is at stake

When you sell your home in Canada, the gain is normally sheltered by the principal residence exemption, which is why most families never pay tax on the increase in their house’s value. The catch with a basement suite is that the exemption is meant for the part of the home you live in and use personally. Earning rental income from a portion of it can put that portion outside the exemption, so that a share of the gain on sale becomes taxable.

The Canada Revenue Agency has a long-standing administrative position that helps here, and it is worth understanding precisely because it is easy to lose. Where the income-earning use of the home is ancillary to its main use as your residence, where you do not make structural changes to convert it, and where you do not claim capital cost allowance, the CRA will generally let you keep treating the whole property as your principal residence and not tax any part of the gain. An Old Ottawa South family renting the basement of the house they live in usually fits that description comfortably. But claim depreciation on the building, or carve the suite into a structurally separate, self-contained unit, and you can step outside that relief and make a slice of your eventual gain taxable. The short-term deduction can quietly cost far more than it saved. The broader rules are set out in the guide to the principal residence exemption.

The moment the use changes

The other event to plan for is a change in use. If you buy the house and rent the whole thing out for a few years before moving in, or move out and convert your former home entirely to a rental, the tax law treats that switch as a deemed disposition at fair market value, a notional sale that can trigger a gain even though nothing was sold and no cash changed hands. There are elections that can defer this, and they are the single most useful thing an owner in this position can know about.

Where a principal residence becomes an income-producing property, an election under subsection 45(2) of the Income Tax Act lets you be treated as though the change of use never happened. It is made by attaching a signed letter to the return for the year the use changed, describing the property and asking for the subsection to apply. Two conditions ride along with it: no capital cost allowance may be claimed on the property while the election is in effect, and the net rental income still has to be reported. In exchange you may designate the property as your principal residence for up to four years in which you did not live in it. The mirror election, under subsection 45(3), covers a rental property that becomes your home, postpones the reported disposition until you actually sell, and is not available at all if capital cost allowance was deducted on the property for any year after 1984. The general shape of these rules is covered in the article on what happens when a property changes use.

Partial changes matter too, and this is where the law moved. Converting the basement from personal use to a rental, or the reverse when a tenant moves out and the family takes the space back, is a change in use of that portion, with its own valuation and its own consequences. For changes occurring on or after 19 March 2019, the same elections can be made so that the deemed disposition arising on a partial change in use does not apply, which was not possible before that date. Where no election is made and the ancillary-use conditions are not met, the portion is treated as sold and immediately reacquired at its proportionate share of fair market value, and a principal residence designation for that portion has to be made on the return for the year of the change. None of this means the basement suite is a bad idea. It is usually a very good one in this neighbourhood. It means the suite should be set up and documented with the sale in mind from the start.

Keep the records that protect the exemption

The practical protection is record-keeping that ties the two questions together. Keep the area split you used and the basis for it, keep every expense and its allocation, keep the receipts for improvements because they raise the cost base and reduce any taxable gain later, and note the dates and values whenever the use of any part of the house changes. A family that can show the rental was ancillary, that no depreciation was taken, and that nothing structural was carved off has a clean claim to the full principal residence exemption when it sells.

Two further points are worth flagging for this neighbourhood. Renting to a student at a discount because they are a family member is not the same transaction as renting at market, and rent below market to a relative can restrict the losses and deductions available. And a suite that comes with meals, cleaning and a level of service starts to look less like property income and more like a business, which changes the reporting in ways covered in the piece on rental income against business income. The same tension shows up across the river, where student rentals around Sandy Hill raise the identical questions with a different housing stock.

That is the whole game in Old Ottawa South: enjoy the rent, deduct what you are entitled to, and do nothing along the way that quietly forfeits the tax-free gain on the family home. If you rent a suite in your home near Carleton and the canal, the Old Ottawa South page sets out the work I do for households here. Send me the floor plan, the lease and last year’s rental figures and I will confirm whether your suite still sits inside the exemption, and whether an election needs to be filed for a change you have already made.