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After boarding the plane to fly home from Calgary this week, one of the flight attendants came over the public address system and said: "Ladies and gentlemen, thank you for flying with us today. We thank you for giving us the business, and trust me, we will enjoy taking you for a ride."

There's nothing like a good laugh to get the conversation on the plane flowing. I spoke for quite some time with the gentleman next to me. He shared with me that he's a vacation property owner and was looking for someone to rent his cottage for the entire summer. "My kids are grown up, live far away, and my wife is not in great health, so we're not using the place," he said.

This led to a conversation about a tax problem that can rear its ugly head any time you start using a cottage or cabin - or your city home for that matter - to earn income. "Walter, you've got a section 45 problem," I told him.

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The rules

So, here's the deal: Any time you change the use of a property from being a non-income property to an income-producing property (earning rents, business income, employment income, etc.), you'll be deemed to have sold that property at fair market value. And this change in use doesn't have to be a complete conversion of the property to an income-producing property. It could be a partial change in use - perhaps you're simply renting out the property for part of the year, renting out just one floor of the property, or using a portion of the home for your business or employment.

Even in the case where you're making a partial change in use, section 45 of our tax law will deem you to have sold that portion of the property that is now being used to generate income. If the property has appreciated in value, this could trigger a taxable capital gain. Now, don't panic. There is an exception and some relief available, which I'll talk about in a minute.

It's worth mentioning that these change-in-use rules work in reverse as well: That is, the rules will also apply when completely or partially converting an income-producing property to a principal residence or changing its use to some other non-income purpose.

If you do happen to convert your holiday retreat or other property to an income-producing property, you'll generally be entitled to claim capital cost allowance (CCA - depreciation for tax purposes) on the property as a deduction against any income you earn. There are special rules that could limit the total cost on which you're able to claim CCA. That is, even though you might be deemed to have sold your property at fair market value when converting it to an income-producing property, you may not be able to use the fair market value of the property as the value on which you can claim CCA. Clear as mud? It's complex, so speak to a tax pro about it.

The relief

Okay, so you've got a potential problem. How can you avoid the potential tax hit when changing the use of your property? First, you may be able to shelter any capital gain by using your principal residence exemption when converting a principal residence to an income-producing property (this won't work when converting an income property to a non-income use).

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Second, the change-in-use rules won't apply if you meet the following three tests: (1) it's only a partial change in use and the new income-producing purpose is ancillary to the main use as a residence; (2) there is no structural change to the property, and; (3) no CCA is being claimed on the property. In this case, you'll preserve the ability to call the cottage (or home) your principal residence and the change-in-use rules won't apply.

Finally, it's also possible to defer the capital gain to a future year if you're subject to the change-in-use rules. You can do this by making a special election. This is available only where you've completely converted the property to be income-producing. This election, which is simply a signed letter attached to your tax return for the year of the change in use, deems the change not to have occurred. This will allow the property to continue to qualify as your principal residence for up to four years after you've changed its use to earn income. This election can be useful to provide relief to those who might be temporarily transferred to other places and may not want to sell their homes while away.

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