12 Feb

Rental Property Tax Planning: To Depreciate or Not

Income Tax

Posted by: Garth Chapman

On your tax return you have the option to depreciate your buildings (to claim CCA).  The elements of this to consider include those below, and perhaps others as well.  This is both a tax planning decision and a mortgage qualification capacity decision. Here are 8 key points to understand and consider when deciding whether to depreciate or not:

  1. Claiming the CCA is actually optional and it can be started and stopped from year to year. Note that from a tax perspective CCA cannot be taken on a property that has the possibility of a principle residence exemption. So while CCA may be beneficial from a tax perspective a conversation is needed with the accountant about the ability to qualify for mortgages. Otherwise the tax savings will leave a sour taste in everyone’s mouth.
  2. CCA cannot be taken on a property that has the possibility of a principle residence exemption.
  3. Claiming CCA reduces your ‘cost base’ for the property.  This results in a higher Capital Gains tax when you sell the property.
  4. If you claim CCA you are depreciating for tax purposes the buildings on the land. The land does not depreciate.
  5. If you claim CCA (depreciate your buildings) you will reduce your taxes now, but you will pay more tax when you sell the properties, as you will have to ‘recapture’ the previously claimed CCA.  This means that you are essentially deferring the taxes due to a future date, and you might also be paying at a rate lower than what you would pay without depreciating.
  6. If you claim CCA the taxes currently saved are taxes on income whereas the future taxes are on capital gains, and there may be a difference in rate between the two.
  7. Consider what your likely income will be at the time you sell the properties, and how that might impact your tax rate then as compared to now.
  8. When you claim CCA you thereby reduce your income from the properties on your tax return.  Lower income can have a negative impact on your ability to obtain further mortgages from some lenders. This is a very important consideration, so consult on this piece with both your tax professional and your Mortgage Broker.

These tips are what I have learned over the years from various Canadian Tax Accountants.  Your own situation is always unique, so always seek out professional advice before you make tax decisions.

Articles containing more information on this subject below:

https://turbotax.intuit.ca/tax-resources/taxes-and-rental-properties/dos_and_donts-cca-for-rental-property-explained.jsp

http://business.financialpost.com/personal-finance/mortgages-real-estate/tax-tips-for-investors-clearing-up-real-estate-confusion

What if I move back in to the property later on?  http://www.mnp.ca/en/posts/changing-your-principal-residence-into-a-rental-property

12 Feb

First Time Home Buyer Tax Incentives and Credits

Building a New Home

Posted by: Garth Chapman

The good news begins with a generous definition of who is a first time home buyer: to qualify as a first-time home buyer, which generally means you and/or your spouse (whoever will be on the Title and Mortgage for the home) must not have owned a home in Canada for 4 years. And now, to the two plans currently available to Canadians.

 

First-Time Home Buyer’s Tax Credit (HBTC)

The First-time Home Buyers’ Tax Credit was introduced to assist Canadians in purchasing their first home. It is designed to help recover closing costs, such as legal expenses, inspections, and land transfer taxes, so you can save more for money for a down payment.

The Home Buyers’ Tax Credit, at current taxation rates, works out to a rebate of $750 for all first-time buyers. After you buy your first home, the credit must be claimed within the year of purchase and it is non-refundable. In addition, the home you purchase must be a ‘qualified’ home, described in more detail below. If you are purchasing a home with a spouse, partner or friend, the combined claim cannot exceed $750.

You will qualify for the HBTC if:

  • you or your spouse or common-law partner acquired a qualifying home; and
  • you did not live in another home owned by you or your spouse or common-law partner in the year of acquisition or in any of the four preceding years.

Program in overview http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/ddctns/lns360-390/369/menu-eng.html

Fact Sheet http://www.cra-arc.gc.ca/nwsrm/fctshts/2010/m01/fs100121-eng.html

 

The RRSP Home Buyers’ Plan – for first-time home buyers (HBP)

The Home Buyers’ Plan (HBP) is a program that allows you to withdraw funds from your registered retirement savings plan (RRSPs) to buy or build a qualifying home for yourself or for a related person with a disability. You can withdraw up to $25,000 in a calendar year. You must qualify as a first-time home buyer, which generally means you and/or your spouse must not have owned a home in Canada for 4 years.

Your RRSP contributions must remain in the RRSP for at least 90 days before you can withdraw them under the HBP, or they may not be deductible for any year – see here http://www.cra-arc.gc.ca/E/pub/tg/rc4135/rc4135-e.html#P233_15310

Generally, you have to repay all withdrawals to your RRSPs within a period of no more than 15 years. You will have to repay an amount to your RRSPs each year until your HBP balance is zero. If you do not repay the amount due for a year, it will have to be included in your income for that year.

All the info here http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/hbp-rap/menu-eng.html

And here’s some more info on how long the money must be in your RRSP before you withdraw it for the HBP.  Let’s say a qualified first-time home-buyer contributed to his RRSP near the end of February.  The buyer then finds a home with a willing seller, but is unable to get a possession date late enough to meet the following requirement: “Your RRSP contributions must remain in the RRSP for at least 90 days before you can withdraw them under the HBP, or they may not be deductible for any year.”

It turns out that the client actually has 30 days after possession to still take out his money from his/her RRSP and use it for the Home Buyer’s Plan.

Moreover CRA does not care if the buyer uses that money to buy a car, go on vacation or spend it on anything else, as long as he/she buys a qualified home and is a first time buyer.

http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/hbp-rap/cndtns/wn-eng.html

12 Feb

Reducing Capital Gains on the Sale of a Cottage/Cabin

Income Tax

Posted by: Garth Chapman

Many Canadians own a vacation property, aka cottage or cabin. And when it comes time to sell that property, as we learned when we sold ours in 2015, there are many things to consider. Not the least of these is the potential tax burden on the sale, which comes in the form of Capital Gain tax if you sold it for more than your capital cost.

It turns out that in fact there are a few options available to help save you tax money, and often the key to this lies in understanding that, while we can only have one principal residence (on which the capital gain is not taxed at time of sale) in cases where we own more than one property we are permitted to designate which property is the principal residence.

Here is an article from MoneySense magazine titled ‘Reducing capital gains on the sale of a cottage’ found here http://www.moneysense.ca/save/taxes/reducing-capital-gains-on-the-sale-of-a-cottage/

12 Feb

Rental Property Tax Planning: Conversion of home to rental status

Income Tax

Posted by: Garth Chapman

More and more often in the last decade or so when Canadians buy or build a new home they have been electing to keep their existing home and convert it to a rental property. Now not all homes make good rental properties, either for economic reasons or due to location or property type, but in many cases this can be an excellent way to further one’s financial independence goals, and/or retirement planning. A good rental property, once paid off, can often produce as much or more cash-flow as your CPP pension payments will generate. So one or two of these can make the difference between a frugal retirement and a rather more enjoyable one.

So for those thinking along those lines, there are a few key things to understand, so I have compiled a few good articles below to help with that.

You will first need to get a proper valuation of the property, as any gain up to the point of conversion to a rental, is tax free. As the below MoneySense article notes “…to convert one home into an income producing property by renting it out. You will trigger capital gains taxes but only from the time you started renting out the property to the time you actually dispose of the property. That’s because the CRA considers the change in the use of the property as a deemed disposition—tax talk for a change in use of a property is the equivalent as a sale at the current, fair market value.” Can you avoid capital gains tax?

CRA website re ‘Change Of Use’ http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/rprtng-ncm/lns101-170/127/rsdnc/chngs/menu-eng.html

On designating a principal residence http://www.taxplanningguide.ca/tax-planning-guide/section-2-individuals/principal-residence-rules/

On Depreciation (CCA) https://turbotax.intuit.ca/tax-resources/taxes-and-rental-properties/dos_and_donts-cca-for-rental-property-explained.jsp

This one contains information on Renting Out A Portion Of Your Home http://deanpaley.com/renting-your-home-can-be-taxing/

Good overview here http://www.taxtips.ca/personaltax/propertyrental/changeinuse.htm

This article also discusses Terminal loss rules, meaning what you should look for if you sold at a capital loss. http://www.taxplanningguide.ca/tax-planning-guide/section-3-investors/rental-properties/

12 Feb

Thoughts on Minimizing Income Tax due on Your Rental Properties

Income Tax

Posted by: Garth Chapman

Couples who own rental properties will often have different income levels which can result in sometimes vastly different income tax rates. So when reporting the Net Rent Income on your tax return most will simply split the Net Income 50/50 as that is the usual ownership split. But are there ways to split the income in order to have more of the income in the hands of the spouse with the lower tax rate, and thereby save money? I think there are.

One very simple method of achieving some savings is to pay from the gross rents received a Property Management fee to the person who manages or does the larger share of the property management. I find that this is often the person with the lower income, as often they simply have more time to devote to looking after the rental properties.

Another method is to have an ownership agreement in place describing a beneficial ownership split other than the usual 50/50. Some investors have different percentages of ownership for Appreciation vs. Income & Expenses. Properly documented, this is fine.

Disclaimer: I am not a tax professional. So, as always, talk with your Tax Preparation professional to determine what will and won’t work in your unique case.

12 Feb

Beneficial Ownership – a route to financing investment properties

Income Tax

Posted by: Garth Chapman

I have purchased well over 100 residential properties since 2002, and I learned early on that it is much easier to finance a property when it is held in your personal name rather than in the name of your Corporation, and this is especially so when dealing with new Corporations.  In fact these days there are fewer lenders willing to lend on rentals held by a Corporation, and those that do either require the Corporation to be a Holding Company, and others who require it to be an Operating Company.  And this list of lenders continues to shrink.

So I have used the concept of beneficial ownership to allow me to buy and hold properties in my name or my wife’s name In Trust for our Corporation.  To allow me to properly record this for each property, especially in case CRA came calling (and we were audited, and passed with zero changes to our tax filings) I had my real estate lawyer drew up a Trust Deed to clearly define that the subject property will be held by me ‘In Trust’ for our Corporation.  This means that the Beneficial Owner of the property is the Corporation.  The Beneficial Owner (the Corporation) must act accordingly, including the receiving of all revenue and payments of all expenses.  And of course it then follows that the tax reporting is handled by the Beneficial Owner (the Corporation) via its tax return as filed with CRA.  When the property is sold, the Corporation receives the proceeds of the sale, and is responsible for any tax on Capital Gains.

When you take out a mortgage in a Corporation you invariably will have to sign personal guarantees for the mortgage, unlike when done in your personal name. This means that if the mortgage goes into default and the bank forecloses, that the bank has the right to come looking to your other assets to cover for any shortfall they may have in proceeds they receive from the sale of the property.

If you do not already hold rentals in a Corporation I strongly advise you to get your tax advisers to weigh in on the implications of holding properties in a Corporation.  One thing to consider it that the net income derived from rental properties held by a Corporation is considered Passive Business Income and is therefore taxed at the highest rate.  Another consideration is the added complexity and costs associated with the Corporation, especially around keeping the books and filing tax returns.

IMPORTANT NOTE- Be sure to discuss this in detail with your professional Tax and legal advisers.  Each of us presents a unique set of circumstances, and as such, there is no one-size-fits-all recipe.

I have several template Trust Deeds for this, each specific to how many Title owners and Corporations are involved in the property.  Call or email me if you want to discuss this concept in more detail.

I hope this helps as you decide how to move forward in building your portfolio of investment properties.

12 Feb

Capital Gains Explained

Financial

Posted by: Garth Chapman

So what is a Capital Gain, as defined in Canada? Well, Duhaime’s Law Dictionary defines it here as follows:

Capital gain or capital gains is an accounting term but one with substantial relevance to tax law as jurisdictions are wont to tax capital gains when the capital asset is sold or otherwise disposed of, just as tax-payers would then seek tax credit or deduction in the event that, in lieu of a capital gain, the tax payer suffered a capital losses.

Therefore, to the extent that it is not expressly defined in a tax statute, what is or is not a capital gain has become a matter of judicial interpretation, often hotly contested as the tax authority seeks to capture transactions as capital gains, and the tax payer seeks to avoid the designation. The law reports contain complex decisions on the status as capital gains of lottery winnings, royalties, business income and many creative tax avoidance transactions.

In more simple language you have a capital gain when you sell, or are considered to have sold, what the Canada Revenue Agency deems “capital property” (including securities in the form of shares and stocks as well as real estate) for more than you paid for it (the adjusted cost base) less any legitimate expenses associated with its sale.

More on all this this MoneySense article with excerpts taken from it below:

How is it taxed? Contrary to popular belief, capital gains are not taxed at your marginal tax rate. Only half (50%) of the capital gain on any given sale is taxed all at your marginal tax rate (which varies by province). On a capital gain of $50,000 for instance, only half of that, or $25,000, would be taxable. For a Canadian in a 35% tax bracket for example, a $25,000 taxable capital gain would result in $8,750 taxes owing. The remaining $41,250 is the investors’ to keep.

The CRA offers step-by-step instructions on how to calculate capital gains.

How to keep more of it for yourself

There are several ways to legally reduce, and in some cases avoid, capital gains tax. Some of the more common exceptions are detailed here:

  • Capital gains can be offset with capital losses from other investments. In the case you have no taxable capital gains however, a capital loss cannot be claimed against regular income except for some small business corporations.
  • The sale of your principal residence is not subject to capital gains tax. For more information on capital gains as it relates to income properties, vacation homes and other types of real estate, read “Can you avoid capital gains tax?
  • A donation of securities to a registered charity or private foundation does not trigger a capital gain.
  • If you sell an asset for a capital gain but do not expect to receive the money right away, you may be able to claim a reserve or defer the capital gain until a later time.

If you are a farmer or a newcomer to Canada, they are special capital gains rules for you. The specifics can be found at the CRA website.

For more specific questions and stories on this topic, see the MoneySense section on Capital Gains here http://www.moneysense.ca/tag/capital-gains/

19 Jul

How to treat Capital Gains on a principle residence when units in the home are rented

Income Tax

Posted by: Garth Chapman

This is a good article I found on the MoneySense website

When you buy real estate you expect that, over time, it will appreciate in value. If you sell that property for more than you paid, you will have an appreciable gain in value and this triggers a taxable capital gain for the Canada Revenue Agency (CRA).
Your home can be an effective tax shelter, but other forms of real estate can attract capital gains taxes. Here’s what you need to know about some of the more nuanced real estate scenarios.

Many readers want to know if their home will continue to qualify for the principal residence exemption if they rent out a portion of their house. Their concern is prompted by stories of people who lost this exemption after years of renting out their basement.

While it’s true—you can lose your principal residence exemption—it really only happens if you rent out more than 50% of your home, or when you decide to claim capital cost allowance on the portion of your home that is the rental. The CRA recognizes that, over time, depreciable property will become obsolete. Believe it or not, this also applies to real estate. Because of this you are well within your right to offset this loss in value by deducting the depreciation over a period of several years. This deduction is the capital cost allowance (CCA). However, if you claim CCA on your home, you are effectively telling the taxman that this property is used to produce income, and you use lose the opportunity to claim a capital gain, which is taxed much more favourably than income.

But what if you buy a duplex or fourplex and live in one unit while renting out the others? Can you deduct costs, including CCA, to offset the rental income you collect each year and still claim a principal residence exemption? Yes: but you’ll need to clearly document what portion is for personal use and what portion is rental. Only deduct expenses for the rental portion. When you sell, you can claim the principal residence exemption for the portion that was for personal use. To understand how this all works, consider the following:

  • Buy a duplex for $400,000.
  • Rent out one unit (for $1,500 per month) and live in another.
  • Each year you report your annual rental income (about $18,000) and then offset these earnings with expenses associated with the unit.
  • Remember: you cannot deduct expenses, including CCA, for the personal portion of the duplex.
  • After four years you sell the duplex for $500,000.
  • Because 50% of the property is used for personal use, you can shelter 50% of the $100,000 capital gain.

But be forewarned: CRA is cracking down on income generated from real estate, and in order to qualify for the principal residence exemption no more than 50% of a principal home can be used for rental purposes. For people thinking of buying and investing homes with a personal use portion you may want to seek out professional advice.
Read on here http://www.moneysense.ca/columns/can-you-avoid-capital-gains-tax/

19 Jul

On Depreciating Rental Properties (aka Claiming CCA) How to Manage this.

Income Tax

Posted by: Garth Chapman

On your tax return you have the option to depreciate your buildings (to claim CCA). The elements of this to consider include those below, and perhaps others as well. This is both a tax planning decision and a mortgage qualification capacity decision.

  • Claiming the CCA is actually optional and it can be started and stopped from year to year.
  • CCA cannot be taken on a property that has the possibility of a principle residence exemption.
  • Claiming CCA reduces your ‘cost base’ for the property. This results in a higher Capital Gains tax when you sell the property.
  • If you claim CCA you are depreciating for tax purposes the buildings on the land. The land does not depreciate.
  • If you claim CCA (depreciate your buildings) you will reduce your taxes now, but you will pay more tax when you sell the properties, as you will have to ‘recapture’ the previously claimed CCA.
  • If you claim CCA the taxes currently saved are taxes on income whereas the future taxes are on capital gains, and there may be a difference in rate between the two.
  • Consider what your likely income will be at the time you sell the properties, and how that might impact your tax rate then as compared to now.
  • When you claim CCA you thereby reduce your income from the properties on your tax return. Lower income can have a negative impact on your ability to obtain further mortgages from some lenders.

The above tips are what I have learned over the years from various Canadian Tax Accountants.  Your own situation is always unique, so always seek out professional advice before you make tax decisions.

 

19 Jul

It’s taxes versus a mortgage for the self-employed

Income Tax

Posted by: Garth Chapman

Canada’s government as been acting since 2009 to tighten mortgage lending requirements in their ongoing efforts to ensure Canadians do not face the ruinous housing collapse endured by Americans and many Europeans since the collapse of 2008.  As a signatory to the Basil Accords along with the USA and all the Euro nations Canada’s government is obligated to comply its banks to adhere to much stricter underwriting guidelines and due diligence.  And this has made it tougher for all Canadians to obtain mortgage financing.  Since Guideline B-20 came into effect in 2012 those of us (myself included) who are self-employed (BFS or Business For Self in industry parlance) have been heavily impacted.

Most self-employed Canadians will, usually following the advice of their Tax Advisers, will focus on lowering their taxable income via the use of various expenses to their business.  This is effected easily both with incorporated businesses and for those operating as proprietorships.  This results in lower line 150 income on the personal tax return, sometimes by significant amounts.

Prior to B-20 guidelines being in effect, such borrowers could qualify by simply ‘declaring’ their income, in effect adding back those deductions, and along with proving their self employed status and often backing up the numbers with bank statements showing the scope of cash flowing through those accounts.

There is an excellent piece on the tougher hurdles Canada’s self-employed now face in getting a mortgage, and what they can do to improve their prospects here in the Globe and Mail’s article It’s taxes versus a mortgage for the self-employed