Plan your tax before the income tax time.
It’s always beneficial for individuals to think through lots of issues before nailing down the property investment transactions. Today, investing a rental property becomes a hot topic conversation these days. But is it that easy as simply going out to sign the paper and becoming a proud landlord?Here are a few tips around tax strategies for investing rental properties.
1-What should be the first thing that individuals consider?
The first thing that everyone needs to understand is what the best option available to own the property and what tax implication is on the income generated from the property. There are different ways to own the property. The ownership structure will ultimately impact how the rental income is being taxed. Based on this, getting professional tax advice is critical as you can imagine, a tax efficient ownership structure can save you a lot of taxes.
2- What is the best ownership structure?
Generally speaking, individuals own the property personally or with other individual investors. Another type is to own the property through a corporation. That means the individuals become shareholders of the corporation, which owns the property. Then the big question is : what is the optimal ownership structure for owning the property? The answer is “depends”. It depends on the individual’s situations. There are more complex structures to own the property like through a partnership or through a trust. A lot of individuals set up the corporation to own the property for liability and creditor protections. So, consult your lawyer and accountant before closing the transaction.
3-How the rental income is being taxed and what else?
The total rental income collected lessees the rental expenses, the net rental income is going to be taxed at the owner’s applicable tax rate, assuming the property is owned by individuals.
Another interesting thing to know about is the integration in Canadian tax system. Ideally, it simply means that the personal tax rates are integrated with the corporate tax rates. What does it mean? It means it does not matter which ownership structure is chosen, either corporation or individual ownership, individuals should pay the same amount of tax. However, the world is not perfect. In reality, there is a bit different.
4-What are the deductions available in the rental business?
Any reasonable expenses that incurred directly for the rental activities can normally be deducted. Generally, the big ticket item is mortgage interest. Watch out, it is not the mortgage payment but the actual interest portion. You can’t write off the cost of land but you can claim the C.C.A. of the building cost. For tax purpose, the C.C.A. rate for the cost of the building is about four percent per year.
5- What if there is a rental loss?
After paying off the mortgage interest, insurance, maintenance costs, individuals may find that the business does not make a profit. So, if you incur a loss, then you can use the loss against other sources of income.For corporations, if the company does not have any other sources of income, then the company cannot use but carried forward for 20 years. Similarly, the company can carry back the losses against prior year’s income as well.
The loss incurred at corporate level cannot be used by shareholders.
6-What is the tax consequence when the property is sold and there is a gain?
These days, a lot of investors make big bucks in selling their investment properties. There are two types of income to be taxed. On the gain, which is the net of the proceeds and the ACB (tax cost of the property), is taxed at 50% inclusion rate. Another trickiest income is the recapture on the depreciable building. If a C.C.A. deduction claimed in the past, the portion of C.C.A. will be included and taxed as ordinary income.
7-Records, records, records
This is a very straight-forward point. A lot of people get into this issue with the CRA. They can’t provide the evidence when requested. Keep complete records. If you are too busy, hire a bookkeeper to maintain the books and remember to write off the bookkeeping expenses as well. You/your accountant may find more deduction available in a clean/organised set of books. Another point to be aware is to better understand the deductible expenses in the rental business. Taking aggressive deductions today may bring more issues later on.6-Can individuals set up his/her own fiscal year for the rental business?
Generally, for individuals, there is no flexibility in selecting its fiscal year for the rental business. Individuals need to use the calendar year to report the rental business income on their T1s. As compared, corporations have more flexibility of choosing an off calendar year.
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