purchase rental property by sburnet3


									                Considering the Purchase of a Rental Property?

If you are considering purchasing rental      Consider the following example:
property for investment purposes, you         • Assume that a reasonable rate of
should make sure that you understand            return    on      a  rental   property
the tax consequences of rental income           investment is 10%.
and the subsequent sale of the rental         • Gross rent collected is $1,800 per
property.                                       month for an annual amount of
Who Should Purchase                           • Being generous the economic value
It may be advantageous to split the             of your investment for rental
purchase of a rental property with a            purposes       is   $21,600/10%     or
lower income-earning spouse. This may           $216,000.
help reduce any tax on the sale of the        • If you purchased the property for
property by allocating the capital gain         $350,000 you are speculating on the
between spouses. However, any rental            difference between $350,000 and
loss in the early years of ownership            $216,000. This means that you are
would also have to be split between             betting that the value of the property
spouses. Each situation is unique and           will go up in value to overcome this
should be discussed with your                   speculation factor.
                                              Rental Income & Expenses
It is possible that a limited company         Revenue
could be formed to purchase the rental        All rents received are considered
property and claim the rental income.         revenue. However, if you are receiving
However, a limited company has to             rental revenue from a person that deals
report this as investment income, which       at non-arms length with you, i.e., a
is taxed at a higher rate and this effect     relative, the rent may only be a nominal
can result in higher income taxes when        amount, in which case the owner would
there is a better way to do it. Also, there   be unable to claim a rental loss since
are additional costs involved with a          there is no profit motive.
limited company such as corporate tax
returns, financial statements and annual      Deductible Expenses
filings with the registrar of companies –       Advertising
see your advisor at MacKay LLP.                 Insurance
                                                Strata Fees
Speculative Nature of a Rental                  Legal
Property Purchase                               Mortgage Insurance
What are the economic factors in the            Accounting
decision-making process of considering          Repairs & Maintenance
the purchase of a rental property?              Utilities
                                                Management Fees
                                                Property taxes
                                                Mortgage Interest

MacKay LLP Chartered Accountants                                                    1
In addition, Capital Cost Allowance          of expenses that relate to the rental
(CCA) on the cost of equipment for the       suite, calculate the total square footage
rental property, such as appliances, can     of the rental suite over the total square
be claimed based on rates prescribed         footage of the home. You would use
by Canada Revenue Agency. E.g. the           this rate to determine the rental portion
CCA rate for appliances is 20% per year      of the expenses mentioned above.
on a declining basis while the building is
4%, and only ½ the normal rate of CCA        You should not claim any Capital Cost
is permitted in the year of purchase.        Allowance on rental income from your
                                             principal residence, as the Capital Cost
Capital Cost Allowance can also be           Allowance will, in all likelihood, be
claimed on the cost of the building          recaptured and taxable when the
based on rates prescribed by Canada          residence is sold. Also all or a portion of
Customs      and     Revenue       Agency.   the capital gain resulting from the sale of
However, you cannot increase or create       your principal residence would be
a rental loss with Capital Cost              taxable – not a good result.
Allowance on the building. Also, as
most real property does not depreciate,      Undeveloped Land
but rather increases in value, any           Because undeveloped land does not
Capital Cost Allowance deducted may          generally generate income, any costs
be “recaptured” when the property is         relating to the land (such as mortgage
sold resulting in additional tax payable.    interest and property taxes) would
                                             normally be added to the adjusted cost
Net Rental Income                            base.
• Rental income must be claimed on
   your tax return and is considered         If rental income is generated from
   earned income for RRSP purposes.          undeveloped land, you can expense the
                                             mortgage interest and property taxes
Net Rental Losses                            each year. Note however, you can only
• Rental losses are deductible against       claim these expenses to the extent of
   other income.                             the income - i.e., you cannot have a
• Accumulated rental losses can              rental loss on this type of property.
   hinder your ability to use the
   $750,000 enhanced capital gains           Sale of a Rental Property
   deduction if you have investments         The sale of the property will result in a
   eligible for it (rental properties are    capital gain or capital loss in the year of
   not eligible).       Cumulative net       the sale. Any proceeds in excess of the
   investment losses (often referred to      cost of the property is
   as CNIL) reduce your ability to claim     considered a capital
   the capital gain exemption.               gain, of which 50% is
                                             the taxable portion.
Principal Residence                          Capital losses can
If you are renting out a portion of your     only be used to offset capital gains, and
principal residence, you may claim a         can be carried back three years and
portion of expenses to offset with the       forward until you die to be applied to
rental income. To calculate the portion      capital gains in other years.

MacKay LLP Chartered Accountants                                                      2
Cost includes:
         Purchase price
         Property purchase taxes (eg. B.C. Property Purchase Tax)
         Legal cost due to purchase
         Improvements and additions

           Proceeds on the sale of the property include the actual proceeds less any
           disbursements such as commission and legal costs.


   Cost of rental property                $ 100,000
   Improvements to roof                      50,000
   Adjusted cost base                     $ 150,000

   Sale price               $ 200,000
   Less disbursements on sale ( 10,000)
   Adjusted cost              150,000
   Capital Gain                           $ 40,000

   Taxable Capital Gain - $40,000 x 50% = $ 20,000
   Estimated Tax rate                         40%

                   Tax due on sale                             $     8,000

Net proceeds from sale might be:

Net Proceeds               $ 190,000
Tax due                       ( 8,000)
Mortgage payout              ( 70,000)
Net cash proceeds $ 112,000

     See your advisor at MacKay LLP to determine if a rental property is right for you.

           This document is general in nature and should not be relied upon to replace specific professional advice.

MacKay LLP Chartered Accountants                                                                                       3

To top