Popular shows on HGTV like Income Property and Flip or Flop have made many ordinary Canadians into landlords and real estate moguls. It’s not uncommon now for a family or an individual to own multiple rental properties to generate income on the side. With interest rates so low, it’s actually possible to get a really cheap mortgage and have the renter cover the cost of the mortgage.
With this practice being so common now, it’s important to know that as a landlord or property flipper, there are many tax laws that you must abide by. Cheating your friend, your spouse or your bank out of money might be something you might be able to get away with, but never ever try to cheat the CRA out of their taxes. Tax fraud is a criminal offence and it can land you a hefty fine from the government, or even worse. Jail time.
The laws are something you should be familiar with if you plan to get into property investment. Don’t let realtors and friends tell you what is right and wrong. It’s important that you understand and abide by the tax rules. Pleading ignorance will not get you off the hook from the CRA.
With tax season upon us, make sure you take the proper steps to declare your income because like any type of income, property income is taxed.
You might not give normal receipts. You don’t collect HST for your rent. You might even be collecting cash for payment. But this does not make you exempt from paying taxes on the rent that you collect.
A big misconception that people have when they are property owners is that the income is tax free. Rental properties are a huge business in expensive cities like Toronto and Vancouver and it’s important that you don’t cheat the government. If you try to cheat the CRA, then you’ll have something worse coming your way than just unruly tenants.
Just because you have to pay a mortgage, doesn’t automatically make your revenue tax free. Even if you price the rent at the cost of your mortgage, you are still making money. There are only a handful of things that you can write off against your rental income and often times people make the mistake of misrepresenting their expenses. There are only a handful of things that you can actually expense:
- Advertising: If you have to pay to advertise your place to rent then it’s acceptable to write off that expense. But with Craiglist and Kijiji being so popular, who pays anymore?
- Interest: This is probably the single biggest thing that can be deducted when you own income property. Only the interest portion of the mortgage is tax deductible. Not the whole mortgage payment. Your mortgage lender will usually send you an annual summary outlining your interest costs for the year. Use that number.
- Maintenance and Repair: If you have to fix the plumbing, rewire the electricity or you have a monthly condo maintenance fee, then you can expense this against your rental income.
- Property Taxes: Unfortunately owning a property does not mean you don’t owe the government money. Property taxes are a big expense and this is one of the things that you can write off as an expense.
- Utilities: If you are kind enough to pay utilities for your clients, then you can expense utilities from your revenue. You can’t, however, expense utilities that you don’t pay for even if it’s used in your house.
- Realtors: If you used an agent to help get your place rented, then the commission fee can be written off as an expense.
There are some other miscellaneous expenses that can be written off, but the above cover most of what an owner can claim. Any remaining revenue after expenses are deducted is profit. Profit is taxed by the Government of Canada like any other form of income. If you live in a province in Ontario, you taxes could be any of the following, depending on your marginal tax bracket.
Unlike capital gains or dividend income from investments, rental income is taxed 100%. It’s exactly as if you were getting paid by an employer. This means you need to add this income on top of any regular salary you might have and be prepared to pay taxes on that.
In Canada, if your house goes up in price you are exempted from paying any taxes on the gains that may arise from selling. The catch? You can only have one primary residence. If you are married or in a common-law relationship, then you and your spouse are entitled to have one primary residence between the two of you. You cannot each have a primary residence.
Thinking of buying for your kids? No such luck. If you have kids that are under 18 and a house is bought under their name, it belongs to you. Minors cannot own a primary residence. The government will not allow this and if you are doing so to avoid capital gains taxes, then you are trying to cheat the tax system.
If you have income property and sell it for a gain then the gain must be declared as capital gains in the year it was sold. Similar to stocks, a capital gain is not fully taxed, but 50% of the profit is taxed. You cannot use expenses to write off capital gains as this only applies to revenue earned from rent and does not apply when selling. You can, however, use capital losses from other investments to offset a capital gain.
The 50% of the capital gain is added to your income in the calendar year that it is sold. This amount gets taxed at the marginal income tax rate that is similar to rental income mentioned above. It’s not uncommon for someone who might have sold an income property to move themselves into the higher tax brackets for the year.
If for some reason you own multiple properties and you end up moving between them during the year, you can still only declare one house as your primary residence. To complicate things even more, changing your primary residence frequently can incur a hefty tax bill.
This happens because when you change your primary residence and declare the previous one as an income property, you are deemed to have sold the old property at market value and then buy it back. What does this actually mean? It means that if you move around, you could be on the hook to pay capital gains tax on a house that you have not really sold, but deemed to be an income property.
As an example. Say you have lived in a home you purchased 5 years ago. You buy a new home for $500K and decide to make your new home your primary residence, but you keep the old one to become an income property. You are not selling the old home, just designating it as an income property. At this point, that first home is considered sold by the CRA. If you have made a capital gain, you will not get taxed on it.
The price that the old home is assessed at at the time you declare your new primary residence, becomes the new baseline for the income property. Say $650k. If after a while you decide that the new home is better off as the income property and you move back to the old property, the reverse comes true now. You now designate the new home as your income property and it is considered “sold” at market rates. Any capital gains are not paid, but the old home that might have risen in value again now gets “sold” at market rates. If the old home now sells for $750k, then you are required to pay capital gains tax on the theoretical value of $100k made.
This rule avoids people from switching principal residences constantly to try to avoid paying capital gains taxes. Playing musical homes with your income properties does not help reduce your tax bill. In fact, it just makes life even more difficult in that you have to track additional information to process your tax return.
If you plan to become a big real estate mogul or even owning a few homes to rent, then it is important to understand the tax ramifications. All the points I mentioned above is through the understanding that you are just a normal investor. If you decide to incorporate your rental business, then all of these rules go out the window, because now you are considered a small business and must get taxed as such.
Just remember that if you confused about these rules, talk to a tax accountant not your real estate agent. The real estate agent wants you to transact in properties because that is how they make their money. A tax accountant can give you a better prospective on how to manage your tax situation in a more efficient manner.
Just remember that if you don’t know the answer to something. Seek the answer. Ask for help.