due to favorable economic conditions, immigration, and historically low interest
rates. Canadians who have taken advantage of these conditions are sometimes
confused about the measures they can take to reduce their tax burden.
Here are some tax tips addressing several typical areas of confusion:
To depreciate or not to depreciate:
Depreciation, or for income tax purposes Capital Cost Allowance (CCA) can be an
effective way to shelter your real-estate income from current taxes by
transferring your obligation to future tax years. CCA works by amortizing a
portion of the cost of your rental property against your rental income,
generally 4% of your building’s cost on a declining basis year over year.
CCA is an election, meaning that it is the taxpayer’s choice whether or not to
use it. The drawback to CCA is that it is recaptured in the year you sell your
property, meaning that the historical CCA you’ve taken will be added back on
income account to your tax return if you sell the property for anything more
than your current un-depreciated capital cost (i.e. the cost of your property
less the CCA claimed on prior tax returns).
This recapture can have a negative impact on your taxes in the year of sale
so some planning around this election is required. Generally, if you plan on
holding the income property for a very long period of time then taking CCA to
reduce your rental profits to zero will almost always be advisable.
However, if you plan on selling your property in the near future you should
attempt to estimate if your potential recapture will push you into a higher tax
bracket, thereby reducing the current effectiveness of the CCA claim. You may
also want to consider forfeiting CCA in years where your overall taxable income
is low thereby allowing you to claim higher CCA in subsequent years when your
marginal tax rate is higher. For more information on CCA see the CRA’s Guide T4036, Rental
Documents, documents, documents
As far as the Canada Revenue Agency is concerned, if your expense
transactions are not documented then they may as well not exist. When you own an
income generating property it is your responsibility to keep adequate records
and supporting documents in an organized fashion. Records would be the
accounting information supporting the final reporting on your tax returns.
Supporting documents would provide evidence of the transactions that make up
your final accounting records.
Contrary to popular belief, simply maintaining banking and credit card
statements is not always considered adequate supporting documentation. Original
contracts, purchase receipts, and other documents should be maintained. In
addition, if you are claiming auto related expenses a detailed log of your
driving should be maintained outlining the dates of travel, the kilometres
travelled, and the reason for travel (it must be to support the production of
your rental income). My suggestion is always: If in doubt, save it. The more
detailed your back-up, the more likely it will pass the scrutiny of a CRA review
or audit. For more information on keeping records and allowable expense see the
CRA’s guides: RC4409 Keeping Records and T4036 Rental Income.
Flipping a Property for Capital Gains?
Thinking of flipping a property and reporting the profit as a capital gain?
You may want to think again. Capital gains are generally favorable to business
or property income for tax purposes because of the fact that only half of your
capital gains are subject to income tax. While the sale of a property held for
the purpose of generating rental income would normally be considered a capital
gain, this is not always a black and white scenario.
Use the analogy of an apple tree: An apple farmer purchases an apple tree in
order to grow and sell apples. The apples are her inventory, while the tree is
her capital property. When the farmer sells the apples she is generating
business income, but if at some point down the road she decides to sell the
tree, she is selling a capital property. If she makes a gain on the sale of the
tree that would be a capital gain and taxed at only half her marginal tax rate.
The same can be said for an income producing property. If you were to buy an
income producing property, rent it out for a decade, profit during that rental
period, then eventually sell the property at a gain, the rental profits would be
taxed at the full rate and the gain on sale would most likely qualify as a
capital gain (taxed at half your marginal rate).
The same cannot be said for short term property flips. When buying or selling
a property on a short term basis for a profit (say buying, renovating, and then
flipping) the CRA may consider the gains to be a type of business income rather
than capital, thereby taxing the full gain at your marginal tax rate. Why is
this? The law distinguishes between properties explicitly bought to generate
rental income and those bought to profit on a sale. The former would normally be
considered capital property to the taxpayer while the latter would be considered
a type of business related inventory or more specifically an “adventure in the
nature of trade.” While there are no concrete rules on whether a transaction is
on capital account or an adventure in the nature of trade there are several
indicators that the CRA and courts would take into consideration. Among these
- Whether the property was bought and sold in a manner similar to a dealer in
- Whether the taxpayer has developed a pattern of buying and selling
properties with short holding periods
- Whether or not the taxpayer’s intentions were consistent with a business
transaction or adventure in the nature of trade.
The determination of whether or not the sale of a property is a capital gain
or business income is complex and has been played out in the courts on numerous
Written by:Fabio Campanella
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