In Wainwright and area the real estate market has never been stronger, and many people are investing in rental properties for income and potential capital growth. Others are utilizing a portion of their home or cottage to generate rental income. Both renting and eventually selling rental property have tax implications which we will explore in the next couple of articles. We will also identify some tax-planning strategies to minimize those future tax liabilities.

In our discussion of rental income, for the sake of this article we will always refer to an individual rather than a limited company. Rental income earned (net of expenses) in any calendar year is reported on your personal income tax, and is taxed at your marginal tax rate. On the other hand, if you have incurred a rental loss (expenses exceed income) you can deduct that against other income earned such as employment or investment income. Because of this potential for large tax savings the Canada Revenue Agency has special rules regarding the type of expenses that can be deducted against rental income.

Any expenses incurred to help you earn rental income are usually deductible. Some of the most common are mortgage interest (but not the principal), property taxes, insurance, maintenance, utilities, advertising, office and reasonable travel expenses related to repairs and maintenance. If you own more than one rental property, the rules are more flexible for travel expenses, collection of rents and management of the properties.

Some expenses you can’t deduct against the rental income are land transfer tax, real estate commissions and legal fees incurred to purchase the property. Other expenses that are not considered deductible are capital expenditures, your own labour or any personal portion of expenses. If you are renting out a portion of your personal residence or a second property, only a portion of the expenses that relate to rental activity are deductible. CRA deems expenses such as taxes, utilities, and mortgage interest to be incurred whether the property is rented or not. Methods to calculate the portion that is deductible is to divide the square footage of the rental portion of the home against the total square footage to determine the percentage. If, as in the case of a cottage, you are renting out the whole property, you divide the days the property is rented by the number of days in the year to calculate the percentage to apply.

The Capital Cost Allowance (CCA) is a method of allowing you to depreciate the value of an asset over its anticipated economic life depending on the specific nature of the asset you own. In this case it refers to the rental building because land is not considered a depreciable asset. Also for rental operations there’s an additional rule that you can not use the CCA to create or increase a loss from rental operations. Another point to consider is if you are renting out a portion of your personal residence you will lose a portion of your personal residence exemption when you eventually sell your house. If you don’t claim the CCA you can claim your full principal residence exemption even if you rent out a portion of your home.

Next week we will discuss the some of the tax consequences when you sell rental property.

June 13, 2008