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Jim Maroney Jim Maroney

:: Calculation of rental expenses so that landlords can shelter rental income from income tax

:: In my last article I reviewed how CCRA expects landlords to calculate the rental income they receive from their tenants. This week I’ll turn my attention to the calculation of rental expenses that can be used to shelter rental income from income tax.

Recall from last week that CCRA expects rental income to be calculated using the accrual method whereby rents are included in income when receivable (as opposed to received) and expenses are deducted when payable (as opposed to paid). Where property owners have virtually no receivables or payables at the end of the calendar year, CCRA permits an alternative method, known as the cash method, to be used to calculate rental income. As the name implies, this method simply records rent received in the year and expenses paid in the year.

Bearing this in mind, the first thing to understand is that, for expenses paid in advance (i.e., prepaid expenses), only the part of such expenses that relate to the taxation year may be deducted. For example, if a rental property is insured for a two-year period only one-half of the payment made in the year may be deducted against rental income in the year.

Tackling the allowable expenses in no particular order, the first, and perhaps most obvious, expense eligible for deduction is the cost of advertising. If you advertise for a tenant you have a deductible expense. Advertising costs include newspaper ads, the cost of signs, internet advertising and so on.

Premiums paid to insure a rental property are deductible, but as I’ve already noted, only that portion that relates to the current year may be claimed. Most landlords purchase annual insurance coverage and typically, because premiums don’t change significantly year-over-year, the deduction is claimed when paid.

With the price of real estate these days it’s a pretty safe bet that the purchase of a new rental property will entail some element of borrowing. Since interest expense is deductible where borrowed funds are used to generate investment income, interest paid on debt incurred to purchase a rental property is deductible. To state the obvious, it is only the interest portion of your mortgage payment that is deductible – the principal portion of your mortgage payment is not deductible. Most lenders provide a summary for the year showing the breakdown between interest and principal.

One of the more contentious rental expenses is the cost incurred to repair and maintain the property. Minor repairs and routine maintenance such as painting are often referred to as current expenses. Current expenses are deductible against rental income, whereas major repairs may or may not be deductible. Non-deductible repairs are known as capital expenses and these costs are added to the original cost of the property for consideration when the property is sold at some future date.

CCRA will consider a number of factors in determining whether a repair and maintenance expense is current or capital: 1. Does the expenditure provide a long-term benefit? 2. Does the expenditure restore the property to its original condition or does it improve the property? 3. Was the cost incurred an integral part of the property or was it a separate asset? 4. What is the relative value of the cost in comparison to the cost of the property as a whole? As you can probably imagine there are no hard and fast rules here. This explains why disputes frequently arise between taxpayers and CCRA regarding the categorization of repair and maintenance expenses.

And before you decide to get too creative, you cannot deduct the notional cost of your own labour if you do repairs and maintenance yourself. People who attempt to do this ignore the fact there is another side to the transaction – that being the reporting of the income by the labour provider.

Strata fees and management and administration fees are deductible. These fees can include amounts paid to agents to collect rents, find new tenants and coordinate maintenance to the property.

Real estate commissions paid to purchase and sell the property are not deductible in calculating rental income. Commissions paid on acquisition are added to the cost of the property when it is purchased; commissions paid on the sale of the property are applied to reduce the capital gain or increase the capital loss when the property is sold.

Somewhat surprising perhaps is the deduction allowed for motor vehicle expenses. CCRA’s administrative position on motor vehicle expenses provides different treatment depending on whether you own one or more rental properties.

If you own a single rental property CCRA’s position is that you can deduct all reasonable expenses if the rental property is in the general area where you live (whatever that means), you personally do part, or all, of the repairs and maintenance to the property, and you use your vehicle to transport tools and materials to the property. Although certainly debatable, CCRA won’t allow taxpayers to deduct motor vehicle expenses to collect rent on the basis that such an expense is personal. But couldn’t it be said that a cost incurred to collect rent is a cost incurred to earn income?

Where two or more rental properties are concerned CCRA will allow a deduction for reasonable motor vehicle expenses to collect rent provided the rental properties are “located in at least two different sites away from your principal residence”. Other than trying to curtail claims for motor vehicle expenses, I’m at a loss to explain the legal basis for this position vis-à-vis the denial where the taxpayer owns a single rental property.

Rental expenses can include office-type expense for supplies such as pens, pencils, paper clips, stationery, stamps and the like. Not big items but they’ll save you a few bucks here and there.

Accounting fees, property taxes and utilities (hydro, gas, telephone and cable) connected to the rental property can also be deducted. Lease cancellation payments and landscaping costs can also be added to the list.

Record-keeping is key when you own a rental property. Be organized and keep track of all costs you incur during the year – you’ll be glad for it when tax-time arrives.



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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