If you own a rental property or planning to purchase one, one of the difficult situation you'll face as a owner of a rental property is how to navigate around taxation. In this article, you will learn about tax implications on rental income in Canada:
Whether you rent out a room in your house, a condo, entire house, or a commercial place, you are considered to have rental income. This means that you have to declare your rental income or losses in your income tax return.
Is Your Property Generating Rental or Business Income?
First off, determine whether your rental property is generating rental income or business income because the tax implications are different for these two categories.
If you are renting our space to your tenants and providing services such as cleaning, meals, security etc., you are earning business income in the eye of the CRA. The more number of services you provide, the greater the chance that a rental operation will be classified as business income. This means you will be declaring your rental income and expenses as self-employed business income along with filing Form T2125 — Statement of Business or Professional Activities.
If you are providing space in a home, apartment building, or office, as well as basic services such as power, heat, parking, and laundry facilities, then you are considered to have rental income instead. As a result, you will need to file the T776-Statement of Real Estate Rentals form.
What are the Tax Impacts of Rental Property?
Tax implications vary depending on who owns the rental property. Generally, there are three ways to acquire a rental property:
Sole Proprietorship
Partnership
Corporation
1. Sole Proprietorship
If you are the sole owner who personally own and manage a rental property, it is classified as a sole proprietorship. This means you will be declaring all of the rental income earned on your tax return as personal income. If you own multiple properties, you’ll have to submit a Statement of Real Estate Earnings (Form T776) for every rental property and as expected, any taxes payable to CRA will depend on your applicable marginal tax rate.
2. Partnership
If you own a rental property with your spouse, friend, or other family member, Canada Revenue Authority (CRA) considers you to be co-owners and you need to determine if a partnership is formed between two parties. CRA describes a partnership as “a relationship between two or more people carrying on a business, with or without a written agreement, to make a profit. If there is no business in common, there is no partnership.”
If partnership exists, no separate tax return is required because a partnership isn’t a separate legal entity. Normally, in the partnership, rental income is shared among the partners and each partner declares a portion of the income as decided in a written or verbal agreement between the owners. As a partner, you will need to include your share of the rental income in your personal income.
In some cases, you may have to include a slip T5013, Statement of Partnership Income with your tax return if one or more of these conditions have met:
Total assets in the partnership exceeds $5 million
Your revenue and expenses exceed $2 million in the given year
The partnership has a corporation
The partnership is a tiered partnership
3. A Corporation
If the rental property owned by a corporation, you’ll have to take into account different aspects when you file tax return. Where sole proprietorship and partnership is NOT a separate legal entry, a corporation is and thus, is responsible for corporate taxes.
The setup of your corporation will determine the corporate tax rate and the tax credits it will qualify for. Special tax rules may applied to your business, we recommend that you get in touch to speak with a professional accountant to ensure that your corporation is structured to work for you as an investor.
What to Report in Your Rental Income?
Generally, you must include all rent you collected from tenants as rental income in the current tax year. You can declare rental income to CRA using two methods:
Accrual method: This method is commonly used by most people. In accrual method, you will include the income in the year it is receivable and deduct expenses in the year they are incurred.
Cash method: This method is based on when the cash is paid by the tenant to the landlord. For example: if you received the first and last month rent, it must be included to the income in the year cash is received.
Once you choose a method, be consistent.
Something else to keep in mind if your tenant offers you with goods and services in exchange for the rent, the fair market value of the goods or services must be included as rental income when filing your tax return.
What Expenses Can You Deduct?
You can claim tax deductions for any expenses you incur to manage and maintain your rental property. If you are renting out space in your house, your deductions are limited to rented percentage of the entire house, otherwise, you can claim the full amount of expenses if it is for a rental property. These deduction can also be claimed if the rental property is temporarily vacant.
There are two type of expenses you can deduct: Capital expenses and Current expenses
Capital Expenses
Capital expenses are generally added to the cost of the property. If you acquire an asset that could depreciate in value over time, such as equipment, furniture, building, you are allowed to claim depreciation expense over a number of years. This is called CCA for tax purposes.
Current Expenses
Many expenses fall into the category of current expenses, which are deductible in the year they are incurred. Some of the current deductible expenses include:
Advertising
Property taxes
Home insurance
General cleaning
Repairs and maintenance
Office expenses
Specific vehicle expenses
Depreciation on capital expenses
Commissions or Realtor fees
Mortgage interest and bank charges
Management fees including salaries
Utilities
Travel expenses
If Your Rental Business has Losses
Rental loss is generated when your rental expenses are higher than your rental income. You are allowed to deduct rental loss from your rental income as well as any other source of income you may have. Any uncollected rent at the end of your tax year also is considered a rental loss. However, if all or portion of the uncollected rent, previously declared as bad debts, is collected in the current year, it must be included as rental income in current tax year. If you are claiming bad debts, you will be required to provide proof to CRA that you were unable to collect the rent.
Finally, not disclosing rental income to CRA can only cause you problems and as a result, you can face significant penalties. Besides, dealing with a CRA audit can be very stressful and expensive process. To avoid these situations, speak with your accountant.
We know there are many moving parts and the entire process is complex and therefore, most rental property owners and corporations opt to hire professionals do the work. If you own rental property(s) or planning to purchase one, Contact Us - we will be happy to help!
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