Rental Property Tax Planning

Rental Property Tax Planning

Many Canadian investors are taking advantage of Canada’s thriving real estate market through acquiring rental properties. Low interest rates and steadily increasing prices allow investors to receive income in the near term in the form of rent, as well as income in the long term through appreciating asset value and capital gains. Investors considering this market must understand the realities and implications of owning property and the impact on tax planning before adding them to their portfolio.

The Basics

Investors are required to report all rental income on their personal tax return, and are permitted to make the following deductions in determining net rental income:

  • mortgage interest (but not principal)
  • property taxes
  • utility costs
  • house insurance
  • maintenance costs (excluding capital additions / renovations)
  • advertising
  • property management fees
  • capital cost allowance (i.e. depreciation for tax)

Rental losses can be applied to reduce other sources of income such as employment income. If rental losses are in excess of other forms of income, they can be carried forward as a non-capital loss and applied to total taxable income in future years.

In cases where a tax payer lives in a property and rents out a portion of the property; expenses pertaining to the whole property (i.e. utilities) are only deductible in the proportion that they relate to the rental property, generally square footage is used in determining the proportion applicable.

CCA (depreciation) may be deducted from rental income, but not to create a loss or increase a loss from rental properties.

Change of use:

There are taxation implications that investors should be aware of when changing the use of a property:

Changing property from personal use to income producing:

Property is deemed to be transferred at fair market value, which if greater than the cost of the property will result in a capital gain. Capital gains are generally sheltered by a principal residence exemption.

There are specific provisions that may allow the owner to avoid deemed “change of use” and the property to qualify as the investors’ principal residence past the actual change in use date. This can result in sheltering more of any capital gain if property is sold at a later date. Consult you professional advisor on ways to keep the principle residence exemption in place.

Changing property from income producing to personal use:

Property is deemed to be transferred at fair market value, which if greater than the cost of the property will result in a capital gain and taxes payable.

This situation is particularly problematic as tax is owing on capital gains, however a sale hasn’t occurred to provide proceeds to pay the tax owing. Specific provisions may allow for tax on capital gains to be deferred until the eventual sale of property. Consult you professional advisor on ways to defer tax owing on the capital gain.

Ownership structures:

Investors have options to own rental property personally or to hold rental properties through other investment vehicles. A summary of some of the tax implications of each are detailed below.

Personally / jointly held:

  • Rental income taxed on a December 31 year end basis
  • Rental income taxed personally, graduated personal tax rates apply
  • Rental losses are available to offset other types of personal income

Corporately held:

  • Rental income can be taxed on corporate year end (ability for corporation to have an off calendar year end)
  • Rental income taxed at the high corporate rate of 46%, however a portion of this tax is refundable when dividends are paid to shareholders
  • Rental losses may be stuck within the corporation with no ability for the investor to off-set personal income
  • There may be non-tax reasons for establishing a corporation (i.e. limited liability of investors / flexibility of ownership / potential income splitting)

Partnerships:

  • Rental income taxed on a December 31 year end basis
  • Rental income / losses distributed taxed personally in the hands of the partners, graduated personal tax rates apply
  • Rental losses are available to offset other types of personal income
  • There may be non-tax reasons for establishing a partnership (i.e. limited liability of partners / flexibility of ownership / potential income splitting)

Whatever rental property investment choices you make … do your homework …. And feel free to reach out to the experts at Welch LLP for great advice!

Mike Moher, Manager
mmoher@welchllp.com
Welch LLP