Renting Property – A Little Tax Planning Can Go A Long Way

by Dean Paley on November 8, 2009

So you have decided to take the plunge. You have a house and lot picked out. The price is right and it looks like you will have a positive cash flow. Perhaps you even have some renters in the pipeline all ready to move in. But you still have questions about the tax implications.

IMG_0462A little tax planning now can save you headaches and money down the road.

The Home Buyers Plan (HBP)

The home buyers plan (HBP) allows each taxpayer to withdraw up to $25,000 tax free from their RRSP to purchase a home in Canada. To qualify you must be a first time home buyer (i.e. you have not owned a home that you lived in as your principal residence in any of the five preceding calendar years before the withdrawal) and the home acquired must be your principal residence. For more information, see my article on the Home Buyers Plan.

In order to use the HBP to acquire your property, you must occupy the home when you take possession within the requirements of the HBP. There is no limit on renting another portion of the property (i.e. the basement) to supplement income or offset home ownership expenses nor are there any restrictions on a future conversion to a fully rentable property (although you should be aware of the impact of a change in use can have and discuss the rules and elections available with your accountant).

Deductions from Rental Income

As a general rule, you can deduct any reasonable expenses against your rental income. This would include maintenance, utilities, mortgage interest, and costs to source renters for the property.

If the property is fully rented you can take the full amount of the expenses related to the property. If you only rent out a portion of the property you are only allowed to take a portion of the expenses against your rental income. This is typically taken as a percentage of the size of the building, either the percentage of the square footage rented or the percentage of the number of rooms rented.

Capital Cost Allowance (CCA)

The Canadian Income Tax Act allows you to deduct a portion of the original cost of a property (the capital cost) from your rental income. The rate to which you can take the deduction is fixed by the income tax regulations and is limited to the “depreciable” portion of the property (i.e. the buildings and not the land).

As of the time of writing, newly acquired property is allowed an annual deduction of 4% of the declining balance of the original cost. Note that in the year of acquisition, you are only allowed to take 1/2 of the allowable CCA (or 2% in the first year).

CCA on rental property is subject to special limitations that further restricts CCA. As a general rule, you cannot use CCA to produce a rental loss. In other words, if you have taken all other expenses before CCA, you can only claim enough CCA that would reduce your rental income to zero.

Like other expenses related to property rental, you can only claim the portion of the property you are renting. Thus if you are renting the second floor of a two story home, you can only claim 50% of the expenses including CCA for tax purposes.

Capital Gains Exemption on Your Principal Residence

If you are renting a portion of your principal residence (i.e. your basement) and you claim CCA, be aware that you will be required to pay tax on a portion of any capital gain on the disposition of your residence. For example, if you were claiming CCA on the rental of your basement apartment and the basement was 40% of the total square footage, you will be required to pay tax on 40% of any capital gain on the sale of your principal residence. This may not always be a bad thing as you may be able to increase your cash flow and reduce your overall taxes by claiming CCA and paying the tax on a subsequent gain on disposition.

Carefully review your options and consider professional advice!

Getting Sound Tax Advice

As your accountants and tax advisors we can help you navigate the surprisingly complex world of real estate and help you pay less tax.

Call us today at (289) 288-1206 or email to make an appointment to have us assist you with your investment.

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