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Real estate Income Tax Rules

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Jim Maroney Jim Maroney

:: Real estate, Mortgages and Rental Income - CRA Income Tax Rules

:: Maroney on Money for April 2, 2004

Real estate has been a pretty hot commodity during the past year or two. With interest rates at historical lows, investing in real estate has become an affordable option. Many have chosen to purchase a cottage on the lake, a ski hill condo or a bigger and better house to live in. Others have taken the opportunity to jump into the real estate rental market. If you fall into this latter category, you’ll need to be mindful of the income tax rules concerning the reporting of rental income and the expenses that can be used to offset such income.

Rental income is reported on an accrual basis meaning that you are required to include as rental income all rents received or receivable during the calendar year. Administratively, the Canada Revenue Agency (CRA) allows a cash basis to be followed where using either method “your net rental income or loss would be practically the same”.

And it doesn’t matter how your rental income is received – be it cash, cheque, in-kind, barter, exchange for services etc. – it’s still considered income and reportable. Form doesn’t matter, substance does.

On the expense side, you can deduct “any reasonable expenses you incur to earn rental income”. Notice the word reasonable – if you don’t notice it now you may later on during a CRA audit.

There are essentially two types of expenses: current expenses and capital expenses. Current expenses provide a short-term benefit and are often recurring (e.g., advertising). Current expenses are a good thing because they are deductible against rental income. In contrast, capital expenses (e.g., an addition to the building) provide a lasting benefit and are not deductible all at once, but rather amortized over a period of time. In some cases, capital expenses may not be deductible against rental income at all. The distinction between current versus capital expenses is anything but clear and you’ll find a mile-high stack of legal cases where the issue has been litigated. This issue arises most often where repair and maintenance type expenses are incurred. Obviously, a detailed analysis is beyond the scope of this article but as a landlord, you need to be aware of the issue nonetheless.

The following is a quick summary of the more obvious current expenses you can deduct against your rental income earned during the year:

Advertising – if you paid to run ads in a local newspaper, print “For Rent” signs, brochures or handbills, you have a deductible expense.

Insurance – premiums paid to insure your rental property are deductible. If your premium covers more than one year, you need to prorate the amount paid and apply a portion to each period covered. Mortgage insurance is not included in this category and not deductible currently – more on this subject in my next article.

Interest – it doesn’t matter to whom the interest was paid, if the borrowed funds were used to purchase your rental property, the interest you incur should be deductible currently. This seems simple enough, however, the subject is actually a bit of a quagmire so you’ll want to read my next article to clarify a few of the issues frequently encountered.

Repairs and maintenance – as previously mentioned, this is a key area giving rise to the current versus capital expense debate. If you paint the inside or outside of your rental property it’s pretty safe to say you have a currently deductible expense. On the other hand, if you substantially renovate the place adding new rooms in the process, you’ve incurred a capital expense that may be eligible for tax depreciation over a period of time. In between these extremes, you’ll find a huge grey area. One final point – sweat equity doesn’t count. If you’re the handy type who likes the do-it-yourself approach you cannot deduct the value of your own labour – end of story. People who think this is possible forget that, as Canadians, we are required to report our income earned from all sources. So, even if you were allowed to deduct the value of your own labour, you’d be required to report the same amount as income so the whole thing would be a wash in the end – big deal, eh?

Management and administration fees – if you pay someone to manage the property on your behalf or if you pay strata fees for a townhouse/condo unit, the cost can be deducted currently.

Office supplies – pens and pencils, paper, paper clips, stamps, ink cartridges for your computer printer and other similar office-type expense are deductible against rental income.

Professional fees – examples include legal fees to prepare rental agreements, collect rents or evict tenants. Accounting fees for bookkeeping, financial statement preparation and the like are also deductible.

Utilities – if your agreement requires you to pay, hydro, gas, telephone, internet and/or cable you can claim a deduction for the amount paid. You can also claim these amounts if you made payments during a period of vacancy while you looked for new tenants.

That’s a quick overview of the more commonly encountered expenses. In my next article, I’ll delve into some detail regarding certain contentious expenses such as financing-related costs, motor vehicle and travel expenses.



Free Tax Advice Article Submitted to Income Tax Canada.net exclusively by Jim Maroney
CA Canadian Chartered Accountant with Brown, Andrews & Maroney in Maple Ridge, BC, Canada

Official details about this and other topics on income taxes can be found in English & Francais at www.ccra-adrc.gc.ca
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