Disclaimer: This article is not meant to be considered taxation or legal advice. Always consult your appropriate legal and tax professionals for advice on such matters.
Have you, or are you thinking about, investing in a new condominium in Toronto? It’s important you understand all the tax issues and benefits that are available to you as an investor.
Let’s walk through an example of a typical first time condo investor.
Samantha lives in Toronto and wants to invest in a condo. She plans to purchase a condo for $365,000, rent it for $1,700 a month for at least three years, and then sell after the value increases. Samantha plans to borrow $200,000 to make this investment. What tax issues are important for her to consider before investing in this condo?
- Making the best use of tax deductions
Following Canada Revenue Agency (CRA) rules, if you own a rental property, any net income or loss must be reported on your income tax return. Rental income is usually reported on a calendar-year basis. Samantha will have a gross rental income of 12 x $1,700 = $20,400. Samantha can use deductions to reduce that income and minimize the tax burden.
All reasonable expenses incurred in operating the property can be deducted. This can include the insurance cost, property taxes, condo fees, mortgage interest, electricity, heat, repairs and even advertising for tenants. If Samantha borrows money to make the down payment on the rental property, interest on that loan is also deductible.
Samantha may also be able to claim depreciation, also called capital cost allowance (CCA), which is normally 4% for residential property. With respect to claiming CCA, the tax implications for Samantha are considerably complicated and for the purpose of simplicity will not be considered for the time being. More information on this topic can be found here.
The CRA allows Samantha to classify certain expenses like repair and improvements into two categories: current or capital expenses. Renovations and expenses that extend the useful life (a lasting improvement) of her property or improve it beyond its original condition are usually capital expenses. An expense considered to recur more often is usually considered a current expense. Current expenses can be used as a deduction against rental income, but capital expenses are added to the original cost of the property for consideration when the property is sold.
Since this will be Samantha’s only rental property, she will be allowed to deduct motor vehicle expenses assuming that her rental property is in the general area in which she lives, she personally does part (or all) of the repairs and maintenance to the property, and she uses her vehicle to transport tools and materials to the property.
- Creating the tax table and a simple ROI table
To highlight how this actually works while keeping things simple, the table below shows how Samantha can deduct reasonable expenses to minimize her annual tax due on her condo rental.
Samantha’s statement of real estate rental:
|Gross rental income from condo||$20,400|
|List of possible deductions:|
|Less annual mortgage interest (first year)||-$7,400|
|Less condo fees ($400 monthly)||-$4,800|
|Less property tax||-$2,700|
|Less legal and accounting fees||-$1,000|
|Less repair to broken closet door, new paint||-$400|
|Less condo insurance||-$350|
|Less motor vehicle expenses||-$275|
|Less advertising for tenants||-$150|
|Net rental income from condo||$3,325|
The net rental income figure of $3,325 would be taxed at Samantha’s marginal tax rate. The resulting tax paid is much less than would be the case if Samantha did not make effective use of deductions to minimize her tax liability. For example, not making use of available deductions greatly affects Samantha’s effective return on income (ROI). As a general tax tip, Samantha should keep an accurate record of all expenses to make tax time something to look forward to!
Return on income (ROI) outcomes:
|Net rental income||Tax paid on rental income*|
* using 40% marginal tax rate
Samantha sees that by using available deductions she can keep $6,830 ($8,160-$1,330) that would have otherwise been paid to the government.
The key thing to consider here is that there are a number of deductions that are unique to Samantha and that another investor most likely has different tax circumstances and deductions available. In any case, professional advice from accountants and lawyers with investment real estate experience should never be overlooked.
The bottom line is this: Strategic investors know and understand that not having a clear tax strategy can be very risky. Samantha should be clear about having a good long term tax strategy in place to avoid serious tax repercussions. It’s highly advisable to consult with a tax specialist when creating a tax strategy. Samantha should have an open dialogue with her accountant to set a clear mandate.