Renting out properties can be a lucrative venture, but it also comes with tax implications that every landlord should be aware of. Understanding how tax on rental income works in Canada is crucial for both new and experienced landlords. In this comprehensive guide, we will delve into the various aspects of tax on rental income, including what is considered rental income, how rental income is taxed, deductions that can be claimed, and tips that can be used to minimize tax on rental income. By the end of this guide, you will have a clear understanding of how to navigate the complexities of tax on rental income in Canada.
Rental income refers to the revenue generated from renting out properties that you own. It includes the rent received from various types of properties such as apartments, condos, houses, office spaces, or even a single room in your own home. Rental income is considered taxable income by the Canada Revenue Agency (CRA), and landlords are required to report it on their tax returns.
Calculating tax on rental income involves determining the gross rental income and deducting eligible expenses. Gross rental income includes all rent payments received in cash, by cheque, or via money transfer. It is essential to keep track of all rental payments and maintain proper documentation to support your calculations. The CRA provides guidelines on eligible rental expenses that landlords can claim to reduce their taxable income. By accurately calculating your rental income and expenses, you can minimize your tax liability.
The tax implications of rental income depend on the type of ownership structure you have. The most common ownership structures include:
Each structure has its own tax rules and regulations, and it is important to understand how rental income is taxed in each scenario. In this section, we will focus on the tax implications for personal ownership.
If you own rental properties personally, your rental income will be taxed based on your personal marginal tax rate. As a self-managing landlord, you are required to report your rental income on your personal tax return using the form T776 Statement of Real Estate Rentals. This form summarizes your rental revenues and deductions and helps determine your taxable income.
Generally, any reasonable expenses incurred to earn rental income are deductible for tax. The two basic types of expenses are:
Some of the deductible current expenses include:
In addition to the eligible rental property expenses, there are also certain expenses that are not deductible. These include:
It is important to keep accurate records and receipts for all rental-related expenses and transactions in order to support your claims when filing your taxes.
Capital Cost Allowance (CCA) is a deduction available for rental property owners to reduce their taxable income. CCA or depreciation allows you to deduct a percentage of the cost of capital purchases, such as furniture and appliances that are purchased for the rental property, over several years. This helps reduce taxable income by allowing landlords to spread out the deductions over time.
However, please note that the CRA has specific guidelines for claiming the CCA on rental properties. For example, you cannot claim CCA to increase your net rental loss.
For tax purposes, CCA is calculated based on the specific CCA rate for the asset and the date it was acquired. The CCA rate for most residential rental buildings acquired after 1987 is 4% per year and common depreciable assets such as furniture and appliances are depreciated at a rate of 20% per year. Other types of depreciable properties may have different CCA rates, so it's important to check with your accountant or tax advisor to make sure you are claiming the correct amount. CRA has a list of depreciable properties with their rates on its website.
In addition to understanding the tax implications of rental properties, it is also important to understand the tax implications of renting out your principal residence. When you start renting out personal property, it is considered a change in the use of that property for income tax purposes. For a better understanding of the income tax consequences, read our article, Airbnb Income Tax in Canada: What You Need to Know.
When selling a rental property, there will likely be either a capital gain or loss. In addition, the recapture of capital cost allowance claimed and terminal loss on the sale of a rental property would also need to be considered in the calculation of the final tax liability. While capital gains are subject to a 50% tax rate, the recapture of capital cost allowance is 100% taxable. In certain circumstances, the sale of a residential rental property could be taxed as business income which is 100% taxable instead of a capital gain. The Federal Budget 2022 outlined some of these new anti-flipping tax rules.
To calculate the gain (or loss), use the step-by-step approach outlined in our blog article, Understanding Capital Gains Tax In Canada.
Recapture
Recapture of capital cost allowance may result when you sell a rental property. In simple terms, CRA requires landlords to report all or a portion of the CCA claimed in previous years as taxable income in the year of disposition of the property. This usually happens when the proceeds from the sale of your property exceed the remaining undepreciated capital cost or UCC. UCC is a tax term used to describe the amount of capital cost that is left of your depreciable property that has not yet been claimed.
For example, if you purchased a residential building for $100,000 and claimed CCA at a rate of 4%. If you claimed CCA of $20,000 over the years and now you are ready to sell your rental property for $150,000, the UCC remaining on the building is $80,000 ($100,000 - $20,000). Hence the recapture on the sale would be:
UCC minus 1 ) lesser of cost or 2) Proceeds of disposition
UCC = $80,000 Cost = $100,000 Proceeds of disposition = $150,000
Recapture = $20,000 ($80,000 - $100,000)
In addition, you will also have a capital gain. The capital gain is $50,000 ($150,000- $100,000), which will be taxed at an inclusion rate of 50% or $25,000.
Terminal Loss
Alternatively, terminal loss may be incurred when the sale price allocated to the building of a rental property is less than the total capital cost allowance claimed during ownership.
Using the same example above, if everything else remains the same but your selling price is $70,000, the terminal loss on the disposition would be:
UCC minus 1 ) lesser of cost or 2) Proceeds of disposition
UCC = $80,000 Cost = $100,000 Proceeds of disposition = $70,000
Terminal Loss = 10,000 ($80,000- 70,000)
When you have a terminal loss, the terminal loss is similar to that of a net rental loss. This means, that the terminal loss can be used to offset against other income. Note that when you have a terminal loss, no capital loss can be claimed on the depreciable property.
As demonstrated in the example above, there are advantages and disadvantages to claiming CCA. On the positive side, CCA helps to decrease your taxable income, resulting in a lower tax obligation. However, on the downside, any previous CCA claimed will be recaptured and treated as taxable income when you sell the property, resulting in an increase in your tax liability in the year of disposition. It's important for landlords to understand how these two concepts work when selling their rental property in order to minimize their tax liability and maximize their profits.
As there is complexity in calculating the recapture or terminal loss amounts, it is recommended to seek professional advice to ensure you are compliant and minimizing your tax liability.
Optimizing tax on rental income requires careful planning and consideration of various factors. Here are some tips to help landlords minimize their tax liability:
How to split rental income between spouses in Canada?
If you and your spouse are co-owners or partners, it is important for both of you to report your portion of the rental income (or loss) for the entire year based on your ownership percentage and pay tax according to their own marginal tax rate. It is essential to note that unless the proportion of ownership changes, you must consistently report your rental income in the same proportion each year.
What is the penalty for not reporting rental income in Canada?
Failure to report rental income can result in significant penalties from the CRA. Generally, if you fail to report your rental income, you may be subject to a negligent penalty. The CRA regularly audits taxpayers if they suspect any discrepancies or irregularities in their reported income. To avoid penalties and ensure compliance with tax regulations, landlords should familiarize themselves with the latest CRA guidelines and take advantage of available technology to simplify their record-keeping. Furthermore, it is recommended to seek professional advice from a tax specialist or accountant to ensure that rental income is being reported accurately and efficiently.
Can you claim a loss on rental property?
In certain circumstances, landlords may be able to claim a loss on their rental property. Any losses claimed must be reported as part of your net income and will offset any other sources of income you have during that period. In order to claim a loss on your rental property, it is important that you rent it out at fair market value. For example, if your rental unit usually goes for $2,000 per month, but you rent it to your family member for $1,000 per month, you will not be able to claim a rental loss in this case. In addition, as mentioned above, CCA cannot be claimed to increase your net rental loss.
How to claim capital expenses on rental properties?
Capital expenses on rental properties may be claimed through deductions such as Capital Cost Allowance. The CRA allows landlords to claim capital expenses over several years, depending on the type of expense. CCA is calculated based on the type of property and its class. Each class has its own depreciating rate.
Understanding the tax implications of rental income is essential for landlords in Canada. By accurately calculating rental income, deducting eligible expenses, and complying with tax regulations, landlords can optimize their tax liability and ensure compliance with the CRA. It is recommended to seek professional advice and stay informed about changes in tax laws to effectively manage tax on rental income. With proper planning and record-keeping, landlords can navigate the complexities of tax on rental income and maximize their financial returns. If you have any questions or concerns about tax on rental income, please contact us. We are here to help!
If you want to learn more about other tax and accounting topics, explore the rest of our blog!
Disclaimer
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.
